East Asian Capital Markets: Challenging Times

Introduction: East Asian Prospects 

1   This conference is taking place at a time of great uncertainty, when attention is focused on geopolitical and security concerns. The short-term outlook for Asia's capital markets is clouded by the prospects of war in Iraq, tension in the Korean Peninsula, and a slowdown in the world economy. With stock markets weak and volatile, investors have turned increasingly risk averse.

2   However, the longer-term prospects for East Asia are brighter than the current gloom suggests. East Asia could well achieve a respectable average growth of 3-5% a year over the next few years, driven by rising Asian consumption demand, intra-Asian trade and a buoyant China. Falling global interest rates and low inflation provide significant room for monetary policy easing. Crisis-affected Asian countries have also improved their public debt positions and with the current low interest rate environment, can afford to run a moderate fiscal deficit. Asian foreign exchange reserves have also climbed substantially over the last few years to some US$1.3 trillion at end-2002, which will help cushion the impact of any external shock. 

3   Asian investment over the last few years has depended much less on cross-border bank lending and foreign currency debt. The bulk of capital inflows have been foreign direct investment, which are more stable and less prone to sudden reversals. Bank lending has moreover been largely in local, rather than foreign currency. Restructuring and the entry of foreign firms into Asia's financial sector has also led to significant benefits to consumers, including wider choices, new products and lower prices. Greater direct foreign participation will naturally increase the potential investor and issuer base for Asia's capital markets.

4   I am therefore optimistic about the prospects for Asia's capital markets.  Let me briefly review some of the trends and challenges in the bond and equity markets, highlight the broad development directions, and suggest a few steps that can be taken to move forward.

EMERGING ASIA BOND MARKETS

5   The aftermath of the Asian financial crisis saw a shift from bank financing towards the development of Asian capital markets, particularly the local bond markets. This was not solely a market-driven phenomenon. Asian governments generally embraced a proactive strategy, recognising that local bond markets provide an alternative source of financing, and soften the blow when a crisis cuts access to international lending. Local bonds also help remove exchange rate and maturity risks.

6   As a result, emerging Asia bond markets have grown spectacularly over the past five years. It has risen fourfold in terms of corporate bond issuance, from US$30 billion in 1998 to US$123 billion in 2002.  Growth is especially strong for Malaysia, China and Korea. Total bond outstanding for Asian emerging markets at end-2001 is about US$1.1 trillion, far larger than Latin America's market size of about US$700 billion.  Asia ex-Japan therefore accounts for more than half of the total outstanding stock of emerging market bonds. 

7   Asian bond markets are relatively more diversified in terms of issuers, as corporates account for a relatively larger share. The corporate sector accounts for 17 percent of Emerging Asia's bond market, higher than Latin America.  Because of their fiscal positions and exchange rate risk, Latin American markets are dominated by domestic government and international bonds, with corporates accounting for less than 4 percent. 

8   Asia's bond market growth has been driven by the need to recapitalise banking systems, to make up for the lack of bank credit after the crisis, and more recently to finance expansionary fiscal policies. Governments have actively taken steps to increase market depth and transparency through preannounced and regular issuance programs, establishing benchmark issues and yield curves, and improving market infrastructure. Both Hong Kong and Singapore have notably taken explicit measures to develop the bond market, even without immediate fiscal needs, because of their role as financial centers and the public-good benefits.   

Growing a Larger Investor Base

9   I think there is considerable scope for continued growth. First, countries should broaden the investor base. Pension funds should  be encouraged to hold both government and corporate bonds. Regulations can  allow for the marketing of bond mutual funds or unit trusts to retail investors. Financial institutions can be allowed to sell bonds directly to retail investors. Capital controls should not impede foreign investor participation in the local bond markets. Longer-term, Asian governments can  consider allowing greater institutional and local investor holdings of foreign bonds, including Asian bonds. Singapore has taken some steps over the last few years in this direction to enlarge the investor base particularly towards the retail and foreign investors, even as banks and insurance companies continue to be the large active players.  

Greater Diversification  of Asian Government Reserves

10   Second, I think there is considerable room for several Asian countries to diversify their reserve holdings into higher-yielding assets. Asian foreign exchange reserves have climbed to some US$1.3 trillion at end-2002. The bulk of these reserves are passively invested in US government securities. The reserve holdings far exceed the requirements for exchange rate management or import coverage. Dedicating a small fraction of the reserves to a wider selection of sovereign and corporate bonds, Asia included, would diversify risks and enhance yields. Such a shift is also timely given the current record low US interest rates.

Improving Market Infrastructure

11   Third, Asian governments should continue to improve their trading, clearing and settlement systems given the growing capital markets. The launch of the Continuously Linked Settlement (CLS) System last September did not go unnoticed in this region. CLS reduces foreign exchange settlement risk and improves liquidity management. In this regard, I am happy to add that the Singapore Dollar will be included as a CLS currency in the middle of 2003. Currently, over 60 international banks involving 7 major currencies, participate in CLS, which settles some US$600 billion foreign exchange trades a day. 

EMERGING ASIA STOCK MARKETS

12   Let me now turn to Asia's stock markets. Growth in capital funds raised in emerging Asia stock markets has largely been concentrated in China and South Korea. Market capitalization for Greater China and South Korea has more than doubled over the last five years; Southeast Asian markets have grown by less than 20 percent. Asian indices, although performing well on a relative basis against US and European indices, have nevertheless fallen across the board because of the uncertainty of war and a global economic slowdown. Going forward, there are opportunities for Asia equity markets to develop further.  What directions can this development take?  Let me highlight a few possibilities.

Listing of Chinese and Indian Companies on Asian Exchanges

13   First, the equity growth in Asia over the next few years would be significantly driven by the capital needs of China and India. Foreign investors are keen to fund these investments, but may be discouraged because of capital controls, insufficient information and different accounting standards. China, on the other hand, faces a long pipeline of companies seeking a listing on its local bourse. Many Indian companies are similarly tapping for funds overseas but face impediments. Regional integration of Asian equity markets can be boosted tremendously if Chinese and Indian companies can list more readily in overseas bourses, including Asia. There are several capital-surplus Asian countries with a strong appetite for China and India exposure. This will help fill the capital requirement gaps China currently faces, particularly from the privatisation of the state-owned enterprises, and remove the pressure on the Chinese stock market because of a glut of issues. The Singapore Exchange has taken steps in this regard to encourage the listing of foreign companies, China and India companies included, on the local bourse.     

Improving Corporate Governance and Transparency

14   Second, as Asia takes further steps to improve corporate governance and transparency standards, it will attract more investors.  Perception towards Asia took a different light when world attention shifted to Worldcom, Enron and Global Crossing. However, Asia still has some way to go in translating these legislative changes to actual changes in corporate behaviour.  Complex cross shareholdings in some countries will take time to unwind.  The recent SK Group episode shows that cross shareholdings can hurt other companies in the stable if there is insufficient transparency and confidence.  The commitment to greater transparency and better corporate governance is there.  It must be translated into action in order to build confidence and trust.

Allowing Country Diversification for Local Retail Investors

15   My third observation is that Asians' investment portfolios are still largely in stocks and concentrated in their own local stocks. This strong home bias is partly driven by regulations on investing abroad and the sale of foreign equities in local markets. Such restrictions remove the potential benefits of diversification. Several small steps can be taken towards encouraging local investors to hold a more diversified portfolio. Mutual funds or unit trusts can be permitted to hold a larger proportion of foreign equities. Local stocks can be allowed to have a second listing on foreign bourses. Pension and insurance funds can be given more flexibility in holding foreign stocks. Asian exchanges should explore the possibility of cross-listings, particularly in neighbouring exchanges where information barriers are lower. Capital restrictions should not impede entry or exit of foreign investment in the local equity market. All these small measures will help integrate the Asian stockmarkets, allow local investors to diversify their risks, and encourage greater foreign participation.    

Concluding Remarks

16   Emerging Asia capital markets on the whole has grown strongly since the Asian financial crisis, but the paths have not been similar for the bond and equity markets. Governments have been successful in promoting the local bond markets, which are slowly becoming a viable source of funding for corporate borrowers. Expanding the local investor base and improving the market infrastructure can further enhance this development. Governments with large foreign exchange reserves can  consider diversifying a portion of their reserves above the amount required for liquidity management needs into higher-yielding assets, especially given the substantial build-up in reserves over the last few years and the current low interest rate environment.

17   Growing the Asian equity markets will require greater collaboration between countries. Both China and India, given their large capital needs, are  in a position to kick-start the integration of Asian equity markets by allowing their  companies to more readily tap regional markets for funds. Asian countries can consider relaxing restrictions, albeit at a considered pace, on purchases of foreign equities to encourage diversification. 

18   These are challenging times but the objective of an integrated and flourishing Asian capital market is, to some extent, within our own control. I wish you all a fruitful discussion during the rest of this forum.
Thank you.