Did China miss the chance to learn from its mistakes?

Two decades have passed since the Asian Financial Crisis, which swept across the region in 1997 as currencies plummeted in key economies including Thailand, Indonesia, South Korea and Malaysia. One country remained relatively insulated: China.

But did it really escape or has it simply deferred its day of reckoning? We asked Jason Pidcock, manager of Elite Rated Jupiter Asian Income fund.

What impact did the crisis have on the Asian economies?

“This shocking period brought about change for many of Asia’s fastest growing economies. A milder recession may not have had the same effect. Since then, we have seen corporate governance and dividend pay-out ratios improve across the region. Arguably, corruption and nepotism that was apparent in some of these countries during that period has also been seen to improve.

“Many countries have been shy about taking on more debt and especially foreign debt as they still bear the scars of the Asian crisis. However, countries that weren’t affected didn’t learn as much.”

What protected China 20 years ago?

“Capital controls, a weaker currency and lower debt levels may have protected China from the crisis two decades ago, but its debt levels have risen considerably since then.

“Over the last decade, the government’s preferred method of propping up the economy has been to increase infrastructure investment. China’s total debt-to-GDP ratio soared to nearly 280% by the end of 2016. Unprecedented levels of leverage are building up in the system, and in my opinion, China’s debt-fuelled growth is simply unsustainable.

“The country’s sovereign debt was downgraded by ratings agency Moody’s last month, who cited the same concerns.”

How would a China crisis affect the region?

“If China were to see its economy contract, it would cause major headaches for other countries, and not just in the Asian region. While you might first worry about those closest to it geographically, actually those who trade with it farther afield might see stronger impacts. For example, somewhere like the Philippines probably wouldn’t be affected as much as Brazil, and Thailand not as much as South Africa.

“A significant difference between the crisis twenty years ago, and a potential one now, is that it would stem from economically very different sized regions. Today, a relatively small economy like Thailand wouldn’t have the same contagion effect as it did twenty years ago, but the downturn of a major player like China would have vast implications.”

So are you investing in China right now?

“The Jupiter Asian Income fund has only 7.8% invested in China at the moment. It is not that we don’t see potential for investment, but we choose to have a medium-to-long term view, which calls for some caution.

“An issue we are particularly mindful of is the potential for market bubbles. Capital controls in China prevent savers from taking their money out of the country easily; as a result, they tend to pile their capital too easily in the ‘hot market asset’ of the moment, until momentum builds and a bubble is created.

“As an investor looking at the medium to long-term, these bubbles are pitfalls that need to be avoided.”