The Association of Southeast Asian Nations (Asean) combines some of the fastest-growing countries in the world with some of the slowest. Thailand grew at just 0.7% in 2014, while the Philippines and Vietnam grew at 6%, according to the World Bank. Malaysia also posted 6%, although this year looks likely to be much tougher for the country, with the currency plunging amid a political crisis, China's devaluation of the renminbi, persistent low oil prices and impending US rate increases.
The pace of growth is not the only point of difference between the 10 nations that make up the Asean region. Their varying levels of economic development (see box), their legal systems and their languages add to the mix, as do the troubled histories of some. Le Luong Minh, secretary general of the Asean, admitted as much in a speech in November 2014.
“In a region as diverse as Southeast Asia in terms of culture and history, the ... members of Asean could have succeeded this far only with the determination to come together with an ever-forward-looking approach to regional co-operation,” he said. But as much as the hurdles to the integration of the region were real, there has been some progress so far.
The perfect conditions for trade Financial market integration in the Association of Southeast Nations (Asean) might be sputtering along at a slow speed, but economic links between the countries have been racing forward. This is, in part, due to the differing conditions for economic and financial market integration. The vast differences in the economic development of the Asean region are perhaps best illustrated by looking at GDP per capita levels. Singaporeans can boast a GDP per capita of $55,182.50, according to figures from Asean. Those in Brunei enjoy $39,678.70 per head. But in Cambodia, the number falls to $1,036.70. In Myanmar, it is just $887.80. These vastly different levels of development, and the corresponding levels of financial market maturity, might create a hurdle for financial integration. But they provide a boon for trade. “In theory, trade prospers the most when you have big differences in economic development, because that's precisely where you accrue benefits,” says Joseph Incalcaterra, an economist at HSBC in Hong Kong. “When one country is labour abundant and another country is capital abundant, that creates the perfect conditions for trade.” That is a key reason the region has been so successful despite some regulatory hurdles, says Incalcaterra. He provides a clear example from Singapore. In 1999, the country produced 70% of hard disks in the region. But ten years later, Thailand had taken much of that capacity, allowing Singaporean companies to move up the value chain towards more research and development. There are still some hurdles to greater economic integration between countries in the region. Indonesia's legal system, derived from Dutch law, creates hurdles when seeking forms of integration with Malaysia and Singapore, with their British law-inspired systems. The wide spread of languages within the region means harmonising documentation can be costly, and laborious. Corporations in some countries fear too much competition from their neighbours. But it is clear that there is progress being made — and room for plenty more in the future. |
Asean countries have worked hard to break down trade barriers within the region, especially in goods, including by signing up to the Asean Economic Community (AEC), which is scheduled to be finalised in December. Trade within the region rose on average by 10.5% annually from 1993 to 2013, according to Asean, compared to 8.9% for trade with countries outside the region. This growth has come on the back of falling tariffs, easier customs processes, and free trade agreements with countries including China and India.
These moves have inspired great hope not just among politicians but also among members of the banking community. Speak to senior bankers around the region and you will hear similar pronouncements. There is a palpable confidence in the prospects for the countries in this region to grow together. The plans for economic integration between Asean countries have already come far, and are set to go even further at the end of the year, when the final terms of the AEC agreement should come into effect.
But although there have been impressive moves in the direction of economic integration, there has been little progress when it comes to financial markets. Those market participants looking at markets across the region say that is no surprise. Change, they argue, needs to come individually before it can be achieved as a group.
Different strokes
The range of financial market development across the Asean region is startling. Cambodia, which has only two companies listed on its stock exchange, does not compare by any metric to Singapore, with its swathes of fund managers, its well-functioning capital markets and its sophisticated banking system. The size of the bond markets, not to mention the knowledge of investors, is wildly different across the region.
From the Philippines to Malaysia, from Vietnam to Thailand, analysts see vastly different financial systems, often with different legal codes that make real progress on integration especially difficult. Given that the size of Malaysia's bond market is easily bigger than those in Indonesia, the Philippines and Vietnam combined, some analysts think it is unrealistic, at this stage, to even be talking about integrating Asean financial markets in any real sense.
“The markets in the Asean region will have to develop more nationally than regionally,” says a well-regarded economist with plenty of experience in the region. “The priority needs to be on the development of domestic bond markets. There is no point integrating markets unless the smaller markets are able to reap the benefits.”
There are signs that this development is already underway. The size of outstanding bonds in emerging East Asia, a region that includes China and Korea as well as Asean countries, grew to $8.3tr in the first quarter of 2015, a growth of 1.6% quarter-on-quarter, according to the Asian Development Bank.
That average contained big differences: Malaysia's market, for instance, contracted 2.7% compared to the previous quarter, thanks in large part to the central bank's decision not to roll over maturing bills; Indonesia's market, in contrast, grew by 6.5% over the last quarter, a result of the government's attempt to pre-fund some of its issuance.
The growth of the region's bond market looks even more positive on a year-on-year basis. Emerging East Asia's bond markets grew by 10% compared to the previous year, driven partly by 22.9% growth in Vietnam and 16.5% growth in Indonesia. But government bonds continue to dominate. Government issuance still represents almost 60% of overall bond sales in emerging East Asia, and is easily more than three quarters of the market in Indonesia, the Philippines, Thailand and Vietnam.
The dominance of government bonds points to a problem. The overall size of the bond market is only around 22.9% of gross domestic product in Vietnam, 36.5% in the Philippines, and a miserly 15.1% in Indonesia. Government bonds swallowing up much of the demand in markets with much larger debt markets is not a problem in itself. It does not appear to have hurt Malaysia, where government bonds represent 57% of issuance and the overall market is worth around 96% of GDP. But when bond markets are much smaller than the size of the economy, the preponderance of government bond issuance means companies are less and less likely to reap the benefits of any increase in cross-border flows.
That does not mean Asean policy makers have few options at their disposal when hoping to increase the financing options for corporations across the region. But it does mean that, rather than focusing entirely on the bond market, they need to take a close look at the banks.
Back to basics
Bank lending is the bread-and-butter of much corporate funding within the Asean region. In Indonesia, Malaysia, the Philippines, Singapore and Thailand, bank loans dwarf the bond market. This is often said by debt bankers to be one of the main hurdles to developing Asean bond markets — the more liquid banks are, the harder it is to break their hold on providing the bulk of financing for corporations. But the dominance of banks does provide opportunities for the region's integration project to move up a notch.
The Asean Banking Integration Framework (ABIF) is one attempt to make the most of the crucial role of bank financing across the region. But there are some doubts about how far the framework will go to integrate the banking system within the region.
The framework is pinned on the hope of "qualified Asean banks" being able to access banking markets across the region. But in reality, any progress will depend on bilateral agreements between countries to allow market access. The framework certainly looks like progress at first glance, but it is more accurate to see it as an invitation to make progress in the future.
“The framework probably doesn't mean much,” says one financial market executive. “But it does show they think [banking] integration is important.”
There have been individual moves to allow more bank access. In the Philippines, for instance, the government has passed a law allowing foreign banks to fully own local institutions, as long as they do not own more than 40% of assets in the entire banking system (see separate story in this issue). But even this demonstrates the small progress being made on integrating banking markets in the region.
Five banks have already won permission to open branches in the country, or to buy small local institutions. But none of these are from the Asean region. Cathay United Bank and Yuanta Commercial Bank are from Taiwan. Industrial Bank of Korea and Shinhan Bank are from South Korea. Sumitomo Mitsui Banking Corporation is from Japan.
These banks are all entering the Philippines not because of any success from Asean policymakers, but because they are trying to find ways to improve the tepid returns they can achieve in their domestic markets.
This does not mean that Asean banking integration is a non-starter. It would be foolhardy to judge the success of the project at such an early stage, or to bet against increasing trade links between Asean countries leading to more banking links. But so far, market participants see Asean banking integration as more of a nice idea than a practical plan. It is, they warn, going to be slow.
It may seem that the hurdles for financial market integration between Asean countries are, at this point, greater than the opportunities. But there is still hope that capital flows within the region will become increasingly important over the next few years. The move towards more capital flows between the region's markets may get its greatest results not from the pull of those markets but rather from the push away from more established offshore markets.
The Fed effect
Senior bankers in the region have long complained that Asean investors, by and large, are more comfortable investing in established economies than in those markets that are closer to home. The high savings rates enjoyed by many Asean countries could be a boon for the region. But, they complain, too much of those savings goes towards helping the US Treasury meet its bond issuance targets.
The low interest rate environment enjoyed in US dollars for the last few years, on the other hand, has encouraged Asean issuers to meet more of their funding needs in the offshore markets, attracted by a captive investor base and a low absolute yield. That part of the equation, at least, looks set to change, as US rates creep up over the next few years and sources of global volatility — including the Greek crisis and China's devaluation of the yuan — make it harder for Asean companies to hit their funding targets in the dollar market.
There are two ways this could play out. Asean countries could chose to meet more of their funding targets in their domestic markets, or they could look for other foreign currency opportunities away from the US dollar market that could continue to offer them cheap funding. Since moving to other Asean markets seems an obvious option for the latter point, it may not matter either way. Asean companies will either add to the domestic issuance in their own market, helping develop those markets to the point at which Asean integration becomes more realistic, or they will go to neighbouring markets, providing an immediate example for those attempting to bolster cross-border flows within the Asean region.
“We have seen an increase in foreign currency issuance at the cost of domestic issuance over the last few years, but now we are starting to see a slowdown,” says Thiam Hee Ng, senior economist in the office of regional economic integration at the Asian Development Bank. “The dollar market still looks attractive to some issuers, but it is becoming less so. That is going to change the approach of Asean issuers to the bond markets.”
This may not shift the needle drastically. The dollar bond market is still going to prove an attractive source of funding for many issuers, and rising rates are going to make it even harder to resist for investors in the region. But as the low rate environment from the US comes to an end, funding executives in the Asean region will increasingly examine their options. That could lead to a boost for the region's debt markets.
This would be a continuation of the project that some bankers, as well as guarantors like the Credit Guarantee and Investment Facility (CGIF), have been working on for a few years: creating examples of cross-border deals within the region even if that cannot, on its own, lead to a deluge of cross-border issuance.
“It's obvious that the development stage of the bond markets are very different,” says Kiyoshi Nishimura, chief executive of CGIF. “That means the hurdles to integrate these markets are large. But having said that, they can still look to increase the flows of funds between markets.”
CGIF has already helped Indonesian issuers Astra Sedaya Finance and Protelindo tap the Singapore dollar market, among other deals. These issues may not fundamentally alter the economics for issuers considering overseas markets, especially those that are shying away from using guarantees. But they do represent real progress for a region in which cross-border issuance is still something of a rarity.
It is clear that the road towards financial market integration is going to be a long one in this region. Few people expect otherwise. But with concerted effort from policy makers, bankers and guarantors —and a little help from overseas — it just might be achievable.