Over the past two years one of the most important forces within the currency markets has been the persistent flow of portfolio capital into Asia. There can be little doubt that the driving force behind these flows has been a belief that the continued extraordinary growth of the Chinese economy would act as a catalyst for the economies in the rest of the region.
In light of the recent news that China’s economy grew by a robust 9.5 per cent in Q4, it is worth noting that there has been a marked pick-up in the pace of inflows into the region’s equity markets in recent months.
According to the Japanese Ministry of Finance’s data, foreign investors net purchased ¥2900bn (e215bn) of stocks between the start of September and the end of December. This took their overall purchases since April 2003 to a substantial ¥19.3trn and their overall ownership of Japanese stocks reportedly to the equivalent of around 22 per cent of the overall value of the market. To put these numbers into context it is worth noting that in the mid-1990s they owned around 10 per cent of the market.
This phenomenon has not been isolated to Japan. A similar renewed interest from foreign investors has been seen in the equity markets of Taiwan, Singapore and Malaysia, among others. As a result, foreign ownership in these markets has also continued to rise.
To take South Korea as an example, since its market was completely opened up in the wake of the financial crunch in 1997, foreign investors acquired 43 per cent of the value of Seoul’s main stock exchange. More particularly, foreigners own over half the shares of representative Korean companies such as Samsung Electronics, Hyundai Motor, Posco and Kookmin Bank.
The impact of these inflows on the region’s currencies has also been fairly straightforward. It is true to say that over the past two years there has been a demonstrably close relationship between the movements of Asian currencies against the dollar and inflows into their equity markets. Since the start of January 2003 there has been, for example, an 85.9 per cent correlation between the inflows into Japanese equities and the performance of the yen against the dollar.
In relatively smaller markets the relationship is even closer. In Taiwan the correlation between foreign purchases of equities and the performance of its currency comes in at 88.2 per cent while in Singapore it is 89 per cent.
The sheer scale of these flows over the past two years inevitably starts to raise concerns about their sustainability. These concerns are only likely to have been exacerbated by the publication of a report from the Institute of International Finance which estimated that net private capital flows to emerging markets overall last year – around $279bn (e213bn) – were at the highest levels since 1997 (in the run up to the Asian currency crisis) and that 52 per cent of these being captured by Asian markets. The report also highlighted that portfolio investment reached an 11-year high in 2004 and that Asia/Pacific accounted for 90 per cent of these flows.
Given this, it is worth noting the warning also contained within the report about the risks facing investors in emerging markets generally. It stated: “There is a risk that the pick-up in flows into some of these assets has pushed valuations to levels that are not commensurate with underlying fundamentals.”
Simon Derrick is head of currency research at The Bank of New York
Researched and published in association with
The Bank of New York
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