Srinivasan: Professor Dufey, Mark, thank you for your time. How do you feel the Asian Tigers have performed during the economic downturn and how do you view their prospects in the near future?

Dufey: The Asian Tigers are happily chasing the tail of the Big Dragon, China. Asia feared the recession was going to be severe, but it turned out brief. Driven by China’s robust policy, various countries in the region have come out of the crisis quite rapidly.

Matthews: There never was any pain. We didn’t experience any major bankruptcies and there were no revolutions as during the Asian crisis. Asia was on the brink of that, but a major crisis was averted thanks to the coordinated government intervention. Southeast Asia escaped with little damage.

Dufey: That’s right. This time, governments had learned Keynesian economics and, where they could afford it, pursued aggressive, stimulative policies, first and foremost in China. 

Srinivasan: Let’s take a closer look at the prospects for the next three to five years. What do you expect?

Dufey: China will play a crucial role in any prognosis regarding the Tigers. Individual countries may face specific problems – the Thais have to overcome internal political divisions, Malaysia has occasional religious issues – but things will be going along well for the Tigers. There is no indication of a double-dip recession and while the Free Trade Agreement (FTA) with China will not initiate dramatic changes, it will have a positive impact in the medium term.

Matthews: I agree. Trade between China and the Association of Southeast Asian Nations (ASEAN) has increased from $60 billion a year in 2003 to roughly $200 billion today. Asia grows and closes ranks at a time when the US has basically not signed an FTA in almost three years.

Dufey: And China will continue to grow, mainly because of a well-known phenomenon: when people move from low-productivity employment in the countryside to assembly lines with technology that is bought, borrowed or copied, double-digit growth is easily achieved. What I am more concerned with is a credit bubble because, frankly, the Chinese financial system is structurally weak. One-third of the financial flows are channeled into investment via an uncontrolled and unsupervised parallel market. Foreign institutions play hardly any role in the Chinese financial sector, and state-owned banks are governed by political considerations. These ingredients make for bad economics.

Srinivasan: Where will the relationship between the Tigers and China go? What can ASEAN and the Tigers do to strengthen their position?

Matthews: The weighting of a country like Thailand has gone from approximately 13% in the MSCI Asia ex Japan Index down to about 2.5%. Some experts argue ASEAN is increasingly sidelined, but I take a more positive view. As India and China continue to grow, they will require increasing amounts of agricultural products. Due to the climate zone the Tiger states are located in, they are in the unique position to provide tropical fruits and vegetables demanded in India and China. On top of that, Indonesia, Malaysia and the Philippines are tremendously blessed in copper, nickel, tin and zinc.

Dufey: Don’t forget Vietnam.

Matthews: Right. Judging from Vietnam’s geographical position it has to be extremely rich in resources. However, as surprising as it may sound, China produces 55% of all vegetables grown in the world. Only 1.5% is exported as the country is home to 1.3 billion people who need to eat and who will be forced to import agricultural products like palm oil from Southeast Asia in the near future. The interdependency between China, India and the Tigers in the agricultural sector can create a well-structured economic relationship. What I am worried about is the manufacturing sector, but I will come back to that later.

Dufey: It is true, Southeast Asia will cause fewer headlines, but I am quite optimistic about the Tiger states. The more developed they are, the more they will benefit, even though I do not expect to see double-digit growth, except possibly in Vietnam. However, a fact remains: problems in China will create problems for the Tigers.

Srinivasan: As Mark has mentioned the MSCI Index, do you see a continued de-rating of the Southeast Asian capital markets?

Matthews: Unfortunately, yes. I find many of the stocks and companies attractive to invest in as they have been operating in free markets far longer than China and often through difficult economic times. But the unfortunate reality is that China and India are bigger, so each Tiger state has to make sure it doesn’t fall off the radar. Singapore has been successful in that respect and Indonesia is the fourth-most populous country in the world and has a good chance of making it. But I worry about the Philippines, Malaysia and Thailand. Right now, they do not merit much attention.

Dufey: China and India may be the biggest players in the region, but Chinese companies will succeed in China only. Some of them are listed in Singapore and are involved in a disproportionate number of scandals. They don’t know the rules for a market economy and, in general, corporate governance is terrible. Southeast Asian companies, to the contrary, have learned to operate internationally and there are quite a number of companies that will have a regional, if not an international impact.

Matthews: Bad economies make good companies. Some of the best companies in Asia are in Pakistan, Sri Lanka and the Philippines: They have to operate in such economically hostile environments that they are lean and mean and good at what they do.

Dufey: That’s absolutely right; especially in view of the fact that one invests in companies, not countries.

Srinivasan: We talked about China and both of you agreed that it will continue to grow. What are the major issues the country will face?

Dufey: China swims in money and it does not know what to do with it. That will not end well. Too much money makes for bad decisions. Chinese companies are now buying resource assets in Southeast Asia and Africa. However, they have no particular skill to run an ore mine in Australia, to use an example. Such investments do not give them anything in terms of security of supply, as Australian authorities will not allow them to sell ore below world market price to China. A pattern of poor investment carries with it the seeds of a China crisis in the medium to long term.

Srinivasan: That is indeed an unhealthy development.

Dufey: Yes, unless you look at it the other way around. There will be wonderful opportunities to buy assets back after a few years at a lower price. China needs to solve its export surplus and capital flow problems internally.

Matthews: What really concerns me is that whole branches in the manufacturing industry could be wiped out in the Tiger states. This is a small anecdote, but locally made nails in Indonesia have been swamped by cheap Chinese nails and the industry in Indonesia has now practically disappeared. And a Chinese white-goods manufacturer has decided to invest millions in factories in Thailand, which will create problems for Thailand’s low-tech manufacturers.

Dufey: There is not only anecdotal evidence to this. Indonesia’s business lobby is already asking for a delay of the FTA.

Matthews: That’s interesting to hear.

Dufey: Yes, but ASEAN is not living on low tech, and the individual countries can still improve their productivity. Chinese labor, at least by some measurement, tends to be three times as productive as Indonesian labor.

Matthews: What do you think about the renminbi? Do you think it is going to revalue?

Dufey: That’s purely a political decision. Chinese policy makers doubt the wisdom of buying more US Treasuries, but there is really no alternative. A few experts in the Chinese economic institutes say this issue must be addressed, and I expect these voices to become louder over the course of the next year.

Srinivasan: Gentlemen, it has been a pleasure. Thank you for sharing your thoughts.