Barclays: High oil prices a threat to Asian economies and markets

The shadow of the bear will continue to haunt Asian stock markets if the current surge in oil prices persist, according to Barclays Capital head of emerging markets research, Peter Redward.

He noted that while Asian economic growth had remained high during the first quarter despite the problems emanating from the US sub-prime crisis, the economic landscape has since deteriorated sharply after oil prices began to surge.

"Much of what has happened has taken policy makers and central banks by surprise," he remarked.

Added Redward, "As oil prices continues to hover above $100 per barrel, it will lead to erosion in current accounts which will lead to a weakening of currencies. This will be followed by higher inflation and interest rates which will lead to a weakening of economic activities."

He pointed out that South Korea and India would be the first to face the impact as the first Asian economies to chalk up trade deficits, while Taiwan and Thailand are the next most vulnerable economies when it comes to balance of payments.

If the current trend persists, Redward expects the Korean won to fall from the current rate of 1,050 to 1,200 against the US dollar and the rupee to fall from 43 to 46 against the greenback by yearend.

"South Korea would be most vulnerable to currency outflows at the moment," he added, while noting that countries that are less vulnerable include China – due to its huge trade surplus; Singapore as well as Malaysia and Indonesia.

Redward however does not expect a repeat of the Asian Financial Crisis of 1997 citing stronger government balances sheets, lower degree of leverage in financial sectors as well as more flexible exchange rates to buffer shocks which were absent back in the late 1990s.

"There might be ripple but not contagion effects as policy makers now are also more willing to come to the aid of each other. The danger of bank defaults is also low," said Redward.

Given the scenario painted if oil prices were to remain high, it's not surprising that Barclays has taken a bearish stance on investment in Asia. It has an underweight rating on all asset classes from equities to fixed-income instruments, preferring cash and defensive stocks.

"So far, the PE (price earnings) contractions have been mild with the exception of Vietnam and Thailand. Earnings growth looking forward will suffer and affect markets," said Redward.

In fact, Barclays has noted in a recent report that "clear direction in global equities is not likely to materialise soon as they are facing downward pressure on PE ratios from higher inflation. The effects of a global inflation shock after a long disinflationary period are unclear at best and ambiguous at worst."

Elsewhere, Barclays expect the growth in the Euro zone to slide from 2.6% last year to 1.6%, dragged down by weaker countries such as Spain, Italy and France though the forecast for Germany remains upbeat at 2%.

It does not expect the US to slide into recession due to the impact of tax cuts and both monetary and fiscal policies kicking in, though any up tick in consumption it will be weak..

"In fact, the Fed has already taken away some of the emergency accommodations implemented during the Bear Stearns bailout," said Redward who expects the US central bank to raise interest rates by 50 basis points before the end of the year, in a bid to shore up the weakening dollar as well as to tame inflation.

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