Asia reforms go far beyond cutting red tape

Added 15th January 2015

Reform-minded governments in the largest Asian economies are driving a change in mindset, which is going largely unnoticed by the global investment community, said Ajay Dayal, investment director at Legg Mason Global Asset Management.

Asia reforms go far beyond cutting red tape
Reforms in these economies (which also happen to be some of the world's largest) have game-changing potential and are opening investment opportunities. 

China's pivot

Starting with China, Dayal said the transition from an export-led economy to one based on domestic consumption is being encouraged through support for healthcare development, education subsidies and greater employment.
State healthcare in China is at a very low level and the concentration of hospitals realtive to the population is far behind Europe or developed Asia, he said.
"China is increasing the number of healthcare facilities, providing more jobs and ideally developing a healthier population. 
"If healthcare is provided at subsidised prices, China is more likely to have consumers who have more money to spend on more things. This is one way China is pivoting to consumer-led growth."
The government is also reducing, closing down or consolidating polluting industries, and encouraging development of clean technologies. 
One such opportunity is electric cars, he said. Investment is going into electric car battery development.
"Energy efficiency standards of new car manufacturing in China are higher than in Europe. So we are seeing standards rise, but a lot of it is not being recognised by the world."
Certain banks are also an opportunity, he said. A recurring question clients ask him is about the level of bad debt provision. 
"Banks are discounting non-performing loans at 10% in terms of share price, but the bank provision for NPLs is 1-2%. 
"Banks are underproviding and the market is over-discounting at 10%. We think even if there will be significant NPLs of about 6%, the banks are still undervalued in China. But it's all about selectivity."

Confidence builders

India and Indonesia will be some of the best currency markets in 2015 because the countries are undergoing "transformation".
Leaders in both countries are driving reform agendas that are succeeding in giving global investors confidence, Dayal said.
"When [Indian Prime Minister Narendra] Modi came on board, investors thought it was hubris to create a reform agenda and didn't believe he was going to cut subsidies because it would hurt the working man. 
"He did cut subsidies and the price of diesel is now free floating, so energy companies can come in and compete with Indian oil. 
"Modi is already changing how India thinks. A `Clean India' campaign is going on. Some think it's to build tourism, but what he really wants to do is make Indians proud of their country. He is asking: What can we do to generate growth in own country? It's a mindset change."
Dayal also said the Reserve Bank of India head Raghuram Rajan, the former IMF chief economist and finance professor at University of Chicago, brought credibility back to the central bank through visibility, and is working in conjunction with Modi.
In Indonesia, President Joko Widodo (Jokowi) also cut subsidies and is pushing through reforms that open up the country to competition and drive economic growth, Dayal said.

Boldness in Japan

Dayal sees bold and ambitious efforts to change the mentality in the world's third largest economy.
Japan's GPIF, the world's largest pension fund with $1.3trn in assets, said late last year it would increase exposure to foreign and domestic equities to 25% of assets (for each category) from the current 12%.
"Japan going out being a buyer will have a huge impact on domestic equities. It won't happen straight away but over time. $100 billion will enter from one pension scheme."
Trust pension schemes and mutual pension funds are also increasing their equity allocations, he said. 
"GPIF is the flag-carrying pension fund. All other pension funds watch how it is allocating money.
"Pension schemes have been happy to earn low interest rates and low returns but the mindset has changed. One-quarter of Japan's 130 million population is over age 65. It has the world's oldest population in terms of percentage, so it's a huge liability longterm. We're seeing recognition that they need higher returns."
Japan equities are still undervalued, despite a 50% year-on-year rise in the domestic market in 2014, he added. 
"Japanese companies are growing earnings and increasing dividends faster than any other country in the world and not being recognised for it."
Yen weakness fuelling exports is often an argument to explain why people are buying Japan equities, Dayal said. But exports are only 15% of Japan's GDP. 
"The domestic economy is what [Prime Minister Shinzo] Abe is trying to fire up. Many think it has been slow progress, but we're talking about changing the behaviour of people."
The snap election late last year was intended to see if the people supported his reforms. 
"This is the Japanese social compact. They are willing to sacrifice now so that the future generation will be better off."

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