Emerging Asia's Investment Crossroads: Why EZA's Downward Pressure Won’t Ease Soon

The iShares MSCI Emerging Markets Asia ETF (EZA) has been a poster child for the volatility of emerging markets in 2023, and its recent struggles are no fluke. After losing over 15% year-to-date, the fund’s decline reflects a confluence of structural and cyclical pressures that are unlikely to abate soon. Investors betting on a quick rebound here may be overlooking the deepening cracks in Asia’s economic foundations.

Geopolitical Tensions: The Elephant in the Room

Asia’s emerging markets are caught in a geopolitical vise. While China’s economic slowdown—its GDP grew just 5.2% in Q2 2023 compared to 8.4% in 2021—has drawn headlines, the bigger issue is the widening divide between the U.S. and China. Supply chain reshoring, tech decoupling, and sanctions on Chinese tech firms have created uncertainty for manufacturers in Thailand, Vietnam, and Indonesia, which rely on Chinese demand.

Meanwhile, the U.S.-China trade war’s ripple effects are now hitting Southeast Asia. Vietnam’s exports to the U.S. dipped 12% in July, with furniture and textiles—key industries subsidized by Chinese capital—taking the brunt. This isn’t just a short-term blip; it’s a reordering of global supply chains that will take years to resolve.

Inflation and Monetary Policy: Walking a Tightrope

Asia’s central banks find themselves in a familiar bind: fighting inflation without choking growth. India’s Reserve Bank raised rates by 25 bps in August, its ninth hike since May 2022, pushing its repo rate to 6.5%. Indonesia’s BI7-day rate now stands at 6.75%, while the Philippines’ benchmark rate is at a 15-year high of 6.25%.

These rate hikes are squeezing corporate profits and consumer spending. In Thailand, car sales dropped 8% in Q2, while Indonesia’s retail sector growth slowed to 4.8%—half the pace of early 2022. With inflation still above central bank targets (India: 4.5%, Indonesia: 5.1%), further hikes loom, creating a toxic mix of higher borrowing costs and weaker economic activity.

The Energy Crisis: Asia’s Achilles’ Heel

Asia’s reliance on imported energy is exacerbating its challenges. Russia’s reduced oil and gas exports to Europe have forced Asian buyers to compete for limited LNG supplies, driving prices up. Japan, which covers 90% of its energy needs through imports, saw electricity costs jump 20% in 2023. Even energy-rich Indonesia is struggling, with subsidies for subsidized fuel consuming 15% of its budget.

The energy crunch isn’t just a cost issue—it’s a competitiveness issue. Vietnam, which built its manufacturing boom on cheap power, now faces rising input costs that could erode its cost advantage over Mexico or Eastern Europe.

Structural Challenges: Demographics and Debt

Beneath the surface, Asia’s emerging markets are grappling with long-term demographic and fiscal issues. Japan’s workforce is shrinking by 0.5% annually, while India’s youth unemployment hit 24% in Q1 2023—the highest in a decade. Meanwhile, debt-to-GDP ratios in Indonesia (62%) and Thailand (58%) are nearing critical thresholds, limiting fiscal stimulus options.

These trends suggest that even if global growth stabilizes, Asia’s emerging economies will face years of subpar returns. EZA, which holds heavyweights like Samsung (005930.KS), Taiwan Semiconductor (TSM), and India’s Reliance Industries (RELIANCE.NS), is uniquely exposed to these risks.

Why the Pressure Won’t Ease

Optimists point to China’s easing measures—a 50 bps rate cut in August and infrastructure spending boosts—as a tailwind for EZA. But the reality is grimmer. China’s policies are yielding diminishing returns: its property sector remains in freefall (property investment fell 8.5% YTD), and household savings rates are near record highs as consumers stay cautious.

Moreover, the U.S. Federal Reserve’s pause in rate hikes isn’t enough to offset Asia’s internal problems. With the dollar still strong and capital fleeing emerging markets, EZA’s 30% discount to its 2021 peak may not be a bargain.

Conclusion: Proceed with Caution

EZA’s struggles aren’t a temporary setback but a reflection of Asia’s structural challenges. Investors should view the ETF as a “high-risk, low-reward” play unless and until there’s a sustained pickup in global demand, meaningful policy reforms in key economies, or a collapse in energy prices. For now, the storm clouds over Emerging Asia are here to stay.

The data is clear: EZA has underperformed the broader market by 20% over the past year, and there’s little reason to believe this trend will reverse soon. For those still holding, the pressure to sell—or at least hedge—will only grow louder.