What Asia Should Learn from Wall Street's Crisis

By Guneet Singh Sahni - Asian Markets

(Article interests: Nasdaq: ASIA, Nasdaq: PRASX, AMEX: PUA, AMEX: NWD, Nasdaq: MEAFX, Nasdaq: EBASX, Nasdaq: EVASX, Nasdaq: MACSX, Nasdaq: MATFX, AMEX: CZJ, AMEX: DIA, AMEX: SPY, Nasdaq: QQQQ, NYSE: NYX, AMEX: DOG, AMEX: SDS, AMEX: QLD)

Shift in Balance of Power

The global meltdown ignited from the U.S. housing sector has sent shock waves throughout Asia. Exactly a decade earlier, when the Asian crisis raised fears of global turmoil, a much bigger Financial Tsunami this time from the U.S. has left Asian economies gripped with fear. Although the origination of the Asian crisis was considered to be flawed fixed rate currency regimes, the complex derivative products referred to as "weapons of mass destruction" by Warren Buffet remain the root cause of last week's global crisis.

Little wonder why no Asian or Middle East sovereign funds, with billions of dollars in their kitty, came in to rescue Lehman Brothers from collapse. Was it high valuation by the Lehman Brothers, or was it that none of these sovereign funds wanted to invest in a plagued business, whose collapse could just be the tip of an iceberg?

It is believed that an offer of $6.40 per share for Lehman Brothers from Korea Development Bank could had helped the fourth largest investment bank avoid its demise, but the talks fell off, owing to valuation concerns. At hour of authoring this piece, we wondered if Morgan Stanley (NYSE: MS), already battling for survival, might also meet the same fate or agree to sell a stake to China Investment Corporation (CIC). CIC is a $200 billion sovereign wealth fund formed by the Chinese Government, which already owns 9.9% of Morgan Stanley. Any further stake raise by CIC will require government authorization; hence, Wachovia Corporation (NYSE: WB) stood to gain here. We didn't foresee a new party entering to take interest in Morgan and take advantage of the regulatory obstacles before CIC; but this morning, MS announced a deal to sell as much as a 20% equity interest to Mitsubishi UFJ Financial Group Inc., Japan's largest bank (specifically 10-20% for up to $8.4 billion). Even so, we wonder if a greater deal with CIC went through, would it signify the beginning of a shift in the balance of power?

Death of Decoupling

The Chinese economy has been significantly driven by exports, which constitute 37.5% of its GDP. Hence, I believe the much visible slowdown in U.S. and global economy will slow China's growth to single digits by six years' time. However, the Chinese central government has more leeway to reduce its interest rates, as inflation has already peaked from a 12-year high of 8.7% in February to 4.9% in August. Consequently, China also reduced its interest rates by 27 basis points to 7.2% last week, signifying the first cut in more than 6 years.

India has the lowest ratio, at 15%, representing the level of its exports as a percentage of GDP in Asia. Additionally, only 5% of its total exports are to the U.S., making India less vulnerable to an export driven slowdown. However, India's macro environment has been deteriorating due to a burgeoning fiscal deficit and double-digit inflation figure. As per NASSCOM data, the Indian IT/ITES sector derives 35-40% of its business from the banking, financial services and insurance (BFSI) industries. Any further slowdown or collapse of more banks would likely lead to a downgrade of the sector. Tata Consultancy Services (BOM: 532540) has the highest exposure of 43.6% to the BFSI sector, followed by Infosys Technologies (NASDAQ: INFY) with 35.8%, Wipro (NYSE: WIT) with 24.5% and Satyam Computer (NYSE: SAY) at 22.9% of its FY08 revenue.

Japanese banks have been the worst hit by the U.S. crisis as a result of their largest exposure in terms of bonds and loans to Lehman brothers. Japan, already on the brink of recession with economic contraction posted last quarter, is more vulnerable to the slowdown in global economy. Additionally Japan's exports to the U.S. have been consistently declining (exports to U.S. declined by 1.2% in CY 2007). As a result, Japan will have to rely on exports to other Asian countries to sustain its growth. On a positive front, Japan has increased its exports to Asia to 51% of its total trade, while U.S. and EU exports to Asia have declined to 17% and 14%, respectively.

As per Financial Services Agency (FSA) info, the subprime loan crisis alone is unlikely to pose a serious threat to Japan's financial system, as levels of Tier 1 capital and profits remain comfortable. However, an imminent risk to Japan is its deteriorating economic condition, caused by worsening terms of trade due to secular rise in commodity prices.

Opportunity in the Making

Chinese and Indian markets have fallen more than 60% and 40%, respectively, touching 21-week and 52-week lows last week. However, if these economies are able to maintain their targeted growth rates, I consider current valuation levels very attractive from a long-term view. So were the favorable responses from these markets, evidenced by surging Chinese shares by more than 9% and the Indian market by more than 5% on Friday, after regulators announced steps to infuse liquidity in the market, signs of things to come? The Chinese government decided to scrap the stamp duty on stock purchases and allowed Central Huijin (an arm of CIC) to buy stakes in Industrial & Commercial Bank of China Ltd. (SHA: 601398), Bank of China Ltd (SHA: 601988) and China Construction Bank (SHA: 601939).

In India, the Reserve bank of India (RBI) decided to go in for two LAFs (liquidity adjustment facilities) every day, instead of one previously targeted. Additionally, the RBI has reduced the SLR (statutory liquidity ratio) from 25% to 24%. These measures have the potential to infuse about INR 840 billion into the system. LAFs are measures that the RBI takes to manage the liquidity in the system and in the present circumstances, through two LAFs per day, the RBI would try to ease the dried up liquidity in the banking system.

Call for better regulation

China has over the years resisted U.S. pressure to open its financial system more quickly and to add new products. Consequently, these barriers have led it to limit its losses and write-downs from the sub-prime crisis. However, the need of the hour is for much better regulation and transparency in Asian nations rather than a closed financial system. Last week's crisis has raised doubts on the model of standalone large investment banks without commercial deposits. Asian countries have a lesson to learn from the financial crisis on Wall Street as a result.

Please see our disclosures at the Wall Street Greek website and author bio pages found there.