ASIA STRATEGY EUROPE’S POINT OF VIEW ON ASIA: BNP Paribas

We are just back from a week’s marketing in Europe. Since our last trip in early 2013, concerns about Asian
equities have mounted due to: 1) liquidity squeeze in EM and USD appreciation; 2) China’s slowdown, which
is increasingly perceived to be structural; and 3) Japan’s reflation strategy and its consequences. However,
investors see some significant investible pockets. We highlight key perspectives and investment themes.
1: Asian equities to bottom out when bond yields stabilise
FII outflows started in the bond markets and the ensuing contagion led to withdrawals from equities. Until
bond yields and real rates stabilise, investors don’t see equities bottoming out.
2: China – the market most European investors love to hate
China’s economic slowdown is perceived to be structural, with eventual restrictions on shadow banking
activities expected to contract liquidity significantly. Sharp valuation discounts have led some investors to
be neutral on China, but they are in a clear minority.
3: Increasing preference for Korea and Taiwan
These exporting economies underperformed in early 2013 on investor concern about the impact of JPY
depreciation on their competitiveness. Such concerns have faded significantly, leading to recoveries in both
markets. For Taiwan, this is a by-product of investors’ clear preference for the technology sector (a
consensus overweight). For Korea, ‘non-Samsung Korea’ seems to be a focus area.
4: India – the default choice
Despite severe macro headwinds, investors’ default choice is India, in marked contrast to the attitudes we
encountered in early 2013. Apart from the relative ease of stock selection, continued commodity price
weakness and anticipation of further moderation are perceived as macro tailwinds for India.
5: More worried about Indonesia than Thailand
In a world of declining commodity prices, Indonesia – with its commodity-heavy export basket – could face
further current account deficit and currency depreciation pressures, though rate increases and fuel subsidy
cuts are perceived as positives. Thailand, though over-owned, appears relatively safe to investors from a
current account perspective and from a growth stability perspective. Neither are investors significantly
concerned about Thailand’s inflation, fiscal balance or credit cycle for the time being.
New themes: Playing consumption through new avenues & ‘safe’ commodities
The resilience of Asian consumption and its changing pattern across Asian countries have led investors to
focus on consumption as a broad theme across the continent. However, investors are looking at new
avenues to play this theme – eg, through Tourism and travel, 4G services in telecom, online retailing and
messaging, and consumer companies listed in DM but growing in EM. On the other hand, Chinese oil
companies, particularly CNOOC [883 HK], are perceived to be relatively safe due to impending growth
prospects, sensitivity to the USD and relatively stable oil prices

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Investors on tenterhooks
We have just returned from an Asian equity strategy marketing trip to Europe, predominantly meeting longonly investors typically benchmarked to GEM or Asia ex-Japan. Investors are focused on three clear themes:
1 The structural slowdown in China and its potential impact on rest of Asia;
2 USD appreciation and rising bond yields in developed markets; and
3 The success of Japan’s reflation strategy and its impact on rest of Asia.
These events affect almost all of Asia, some more severely and some less. Investors therefore believe stock
selection in Asia is tougher than it has been for some time, but that some investible pockets exist.
Asian equities: To recover when bond yields stabilize
Investors were near unanimous in pointing out that outflows from EM actually started in the bond markets
in Q1 2013 and accelerated in Q2 after the Fed chairman’s ‘trial balloon’ of a potential tapering of QE. With
the sharp increase in developed market real yields, investors believe the ‘hunt for yield’ that was driving
inflows into EM bonds is no longer a strong enough reason for buying the latter.

From the perspective of foreign ownership, bond yields look relatively more vulnerable in Indonesia and
Malaysia, and less vulnerable in India and Korea, as BNP Paribas FX strategists Yii Hui Wong and Rohit Garg
point out (“Asian Bond Vulner-o-meter” 31 May). Indian government bonds have seen an outflow of
USD3.3b from foreign investors in June. EM bonds saw an outflow of USD2.5b in just the past week,

according to media reports. Apart from the expected impact on bond yields over past four weeks
(Indonesian yields up 80bps, Malaysian yields up40bps), Asian currencies have collapsed – particularly in
current account deficit countries – with the Indian rupee down 7% and the Indonesian rupiah down 2.8%
over the same period.
Stabilisation of DM bond yields and real rates are therefore the key lead indicator that investors are looking
at to assess whether volatility in Asian equities is likely to decline or not.
China – the market European investors love to hate
A significant majority of European investors are averse to investing in China, particularly in Chinese cyclical
(banks, industrials), area because:
1 Economic slowdown is structural as evidenced by declining capital efficiency and the need for larger
amounts of credit to generate incremental units of GDP. The consensus view is that this has been
brought about by the huge over-capacities created over the past several years; and
2 With the eventual curtailing of shadow banking activities in China, credit flow to smaller corporates will
become tougher.

Most investors agree that continued slowdown in China will mean continued moderation in commodity
prices, such that commodity users with a relatively stable demand profile for their products will benefit.
We did encounter a small minority of investors who have taken the call that commodities have bottomed
out, and who have moved into mining stocks – but they were a very small minority. We also met a small
minority of investors who were neutral on China (through consumers and consumer proxies) because of its
severe valuation discount.

India: remains the default choice
Despite severe macro headwinds, investors’ default choice by and large remains India. This is a marked
change in attitude from the sentiment on India we encountered a year ago, and more bullish than in
January 2013. There are investors whose only overweight in the Asian portfolio is India. While such
investment sentiment is clearly reflected in massive FII inflow into India (USD15.5b till May – 80% of Asia
6), the macro risks (particularly the large current account deficit) are making investors jittery. In an
environment of the USD appreciating against all EM currencies, currencies of countries with large current
account deficits look particularly vulnerable. Quite possibly the last few days of FII retrenchment is a
reflection of such risk perception. However, continued commodity price weakness and anticipation of
further moderation are macro tailwinds for India which some investors are willing to play through
liquidity-driven sectors like banks and consumer discretionaries.
Meanwhile, investors’ medium-term stock selection in India remains focused on a few themes:
1 Safe banks and safe segments of banking activity: ICICI Bank, HDFC Bank, Axis Bank and mortgage
lenders HDFC and LIC Housing Finance;
2 Beneficiaries of USD appreciation: IT (HCL Tech) and Pharmaceuticals (Sun, Dr Reddys);
3 Stocks with predictable cash flows and de-leveraged balance sheets: investors are clearly willing to pay
expensive valuations in exchange for safety – ITC, M&M, Bajaj Auto, Sun Pharma, and other consumer
and pharmaceutical names; and
4 One important difference from our previous trip in January is that we now met with requests for “good
quality” mid-caps in India.