Confident and a little cocksure

Asians do their best not to gloat, yet many may be tempted as their stock markets outperform those in the West. They shouldn't be jubilant for too long, though - next year will be a challenging one.

Judging from the scene this week in Vientiane, Laos, where the Association of Southeast Asian Nations this week held its summit, Asians are the most confident since the region's financial crisis of 1997.

Leaders are cheering the return of healthy growth, the increasing number of middle-class consumers and the many investor-friendly reforms that are afoot.

At the same time, most Asian economies boast what Western ones lack: swelling populations, growing cities, evolving markets and an ample supply of consumers hungry to display their new wealth. Equities here are still believed by many to be undervalued. And a sense of political stability is returning to a region that enjoyed little in the late 1990s.

Asia also is home to the world's sexiest economy: China. For all its problems - banks riddled with bad loans, poverty - China's 9 per cent growth is proving to be the powerful engine Asia lacked after Japan slid into deflation in the 1990s.

While Asia has much to be thankful for now, it is edging towards a potentially troublesome year. Asian stocks are not expected to slide and, barring a meltdown in China, economic growth is not about to grind to a halt. Yet the focus next year will shift from growth and equity values and back to basics. Debt, in other words.

How successfully policymakers use today's healthy growth to reduce debt levels may offer signals to investors about which Asian economies to entrust with their capital in the years ahead.

"Heavy debt burdens continue to be a threat to medium-term economic performance in many countries in the region," says David Burton, Asia-Pacific director of the International Monetary Fund.

"Asia needs to use the present period of strong growth to reduce fiscal imbalances and lower its fiscal vulnerability."

Here are five Asian debt-related trends to watch in 2005:

* A Chinese currency revaluation. With China scrambling to slow inflation and cool economic growth, relaxing the yuan's decade-old peg to the US dollar is becoming more likely.

A revaluation could have positive effects in Asia. It would allow other economies to let their currencies rise, too. That could attract more foreign capital, boosting stocks and lowering bond yields. For another, Asia could make more productive use of the vast currency reserves it has parked in US debt. That could improve the quality of Asian growth.

* A Japanese slowdown. If 2004 was the year in which investors declared the arrival of Japan's long-awaited revival, 2005 may be the year when many eat their words. Japan now has its best chance in a decade to restore vibrant growth. Trouble is, its recovery is mostly an export-driven one that hasn't spread to the all-important consumer sector.

Slower growth in Japan can't be good news on the bond issuance front. Already the world's biggest issuer of Government debt, Tokyo might have little choice but to boost bond sales next year. It means Japan investors may have less cash to move overseas into other Asian debt markets.

* Healthier developing economies. True, emerging markets as a whole have ratios of total debt to gross domestic product above those of industrial nations - and much higher when viewed as a percentage of Government revenue.

Yet the growth in public debt in the second half of the 90s was especially rapid in emerging Asian economies, from about 40 per cent of aggregate GDP in 1996 to about 65 per cent, said Burton. If Asia uses today's growth to reduce debt, tomorrow's prosperity will look even better.

* Chinese debt sales. Investment banks are scrambling to get in on the next Chinese gold rush: more than US$450 billion of bad loans held by China's four-biggest commercial banks and their asset management companies. The hope is to buy dodgy loans at a fraction of their face value and sell the assets at a profit as the world's fastest-growing major economy expands.

It's as much an economic opportunity as an investment one. China may be growing 9 per cent and sucking up most of the world's foreign direct investment, yet its dysfunctional banking system is raising questions about its economic outlook.

* Reduced risk of a debt crisis. With India and Indonesia under new leadership, China working to fix its banks, South Korea growing 5 per cent, Japan hardly a default risk and even the Philippines taking a fresh look at deficit reduction, the risk of dangerous turbulence in debt markets in 2005 seems scant.

So the year of the rooster may not be one of turmoil for Asia's markets, and that's hardly a bad thing.

- BLOOMBERG