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There are three sovereign risks lurking in Asia that investors need to, at least, have on their radar, according to Societe Generale.One is well talked about, another is surprising, and the third could be an imminent treat.
First, the obvious, Japan. The threat here is an interest rate shock results from rising inflation, that quickly increases the country’s debt servicing costs, which are now kept low by heavy domestic investment in Japanese sovereign bonds.
From Societe Generale:
Thus, rising inflation, whether imported or internally generated, will be of a significant concern for Japan. Ironically, a robust, quick and sustained recovery in the global economy could bring about a tragic outcome for Japan in the next few years.
Now, the shocker, China. The country’s problems lie with local banks, which have made big loans to local governments (LGFPs). As the Chinese central bank raises rates, it becomes more difficult for borrowers to pay back debts. If the Chinese were have to bail local banks out, government liabilities would spike as high as 50% of GDP.
But it doesn’t seem that likely, from Societe Generale:
Yet, immediate risk probably remains low. The investment cycle in China is usually about 3-5 years, so given the timing of most of these LGFPs creation and maturity, peak risk is likely 2012-14. If inflation is back under control within the next year, then the policy and growth cycle could help ease the financing concerns.
Finally, the imminent threat, Vietnam. The country is experiencing high inflation, a weakening currency, and the default of a major state owned corporation. And, there is the potential that an economic slowdown could lead to a banking crisis.
From Societe Generale:
If Vietnam is to turn into a sovereign debt crisis, it likely will derive from a cash flow issue, perhaps stemming from a critical loss of growth momentum, triggering a local banking crisis first. Credit quality in the banking sector has been highly questionable, especially after the rapid expansion over the past decade (more than doubling to more than 100% of GDP over the past 8 years).
Unfortunately, the government does have much money lying around to spend, and is unlikely to be able to raise more on the open market.