Published Date: 14 May 2007

Trends and Developments in the Asian Liquid Markets


1   Good evening.  Before I begin, I would like to congratulate Lehman Brothers on the conclusion of a very successful conference.  I’ve been asked to talk about liquid markets in emerging Asia.  This topic is very close to my heart, since I’ve been involved in these markets both as an investor as well as a developer for many years.  For a topic like this, it is helpful to use the Asian financial crisis of 1997 as a reference point.  This is apt, not just because this is the 10th anniversary of the crisis, but more importantly, because there are, I would argue, some prima facie evidence that the frothy conditions that existed before ’97 are upon us again – large inflows of liquidity, very low interest rates, and record-high stock prices.  So the question will inevitably arise: Has Asia really changed over the last ten years, or are we marching towards another crisis yet again?

2   I’ve divided my remarks into two broad sections.  In the first, I’ll give a brief overview of how Asian markets have evolved in the last ten years, and how they are likely to evolve in the next ten.  In the second section, I’ll offer an opinion on whether Asian markets have really changed, or are we now better prepared to avoid another crisis.  As usual, the opinions expressed here are my own, and do not necessarily reflect those of the MAS.

Evolution of Asian Markets in the last 10 years

3   So how have Asian markets evolved in the last 10 years?  It is always a bit tricky to talk of Asian markets as a collective entity because they are really a very diverse group.  However, at the risk of over-generalization, it is fair to say that over the last ten years,  Asian markets have become bigger and broader. 

4   Bigger and broader in the sense that market caps have grown tremendously, and new instruments have emerged.  In the FX market, more currency-pairs are now traded actively.  Currencies like the Won, Baht and Rupiah which used to be pegged to the dollar were freed after the crisis.  From July 05, the Chinese RMB and the Malaysian Ringgit have also been unpegged.  To be sure, not all of these currencies are fully accessible to international investors.  But where interests are strong, offshore NDF markets have emerged. 

5   In fixed income, Asian authorities began developing their domestic bond markets after ‘97, to provide an alternative channel for corporate financing besides bank lending.  Measures were taken – both within each country like developing a government yield curve, market-making structures, settlement systems and so on; as well as regionally through a group like the Asian Bond Market Initiative and the Asian Bond Fund.  The measures were fairly successful.  Over ten years, the market cap grew 5 times to almost US$3 trillion.  Indeed, if one should construct a global index of emerging bond markets today, weighted using purely by market cap alone, Asia will count for more than half of it.  Along with development of the bond market, trading of interest rate derivatives also grew.  In Hong Kong and Singapore for example, daily turnover in the IRS market is now many times that of the cash bond market. 

6   In the equity space, stock market capitalization has grown tremendously, rising 4.5 times to more than US$6 trillion.  This partly reflects the strong post-crisis recovery and perhaps more importantly, the offerings of Chinese companies on stock exchanges.  While a lot of attention has been drawn to the multi-billion offerings of Chinese banks in Hong Kong and Shanghai activities, other exchanges in Asia have also benefited.  In Singapore, for example, Chinese companies accounted for half of IPOs last year.  

Next ten years

7   I believe this pace of growth will continue in the next 10 years.  Excluding Japan, Asia accounts for 15% of global GDP, but only 5% of global stock market cap and 3% of global bond markets.  From an asset allocation perspective, one may argue that global investors are under-invested in Asia.  There is room to grow.  With G3 growth at 2-3% and Asian economies growing at 7-8%, the demand for Asian assets should increase.  But where will the supply come from?  Apart from the more obvious sources like privatization of Chinese and Vietnamese SOEs and the strong issuance of real estate related products like REITs, I’m also optimistic about 2 additional areas where many investors will come in: infrastructure and loans.

8   Strong growth and rapid urbanization is putting basic infrastructure in many Asian countries under tremendous strain.  The ADB estimated that East Asia needs to spend US$250bn a year over the next 5 years on basic infrastructure.  This is the desired level of spending, which does not make much commercial sense.  In truth, of course, only a portion of these can be afforded.  It is clear, however, that the sheer size of this spending needs means that increasingly, more projects will have to be privately financed – and increasingly through capital market instruments like infrastructure bonds and funds.

9   The other area, loans, both in the form of small consumer and business loans and in the form of large leveraged loans, will also increasingly find its way into capital markets.  There are 2 factors driving this.  First, the introduction of Basel II will prompt banks to unload loans to capital markets to use their risk capital more efficiently.  Second, the rise in LBO activities in Asia may spur the growth of a leveraged loan market, similar to that in Europe.  In 2006, LBOs in Asia reached roughly US$30bn, more than double the level in 2005.  This year, with more private equity funds focusing on Asia, LBO activities are expected to grow further.    

Will the Asian Crisis be repeated?

10   So Asian markets have become bigger and broader in the last ten years, and will likely become even more so in the next ten.  But bigger and broader, does not necessarily mean deeper and safer.  This brings me to the second section of my remarks.  After ten years, has Asia’s financial system become more resilient, so that should there be another sudden reversal of liquidity, a crisis will not ensue?  This is a question that is quite keenly debated and there is no easy answer.  I will offer two factors that give me some comfort, and two that gives me some cause for concern.

11   The first factor of comfort character is that of liquidity type. There is evidence to suggest that the global flow of liquidity into riskier assets, and this would include emerging Asian assets, may be structural in nature, rather than being purely cyclical.  The strong performance of risky assets has gone on for almost 4 years now.  During this time, the Fed has raised its rates from 1% to 5.25%, the ECB from 2% to 3.75%, and the BOJ has moved away from its zero rate policy.  This suggests the rally is not merely an easy monetary policy phenomenon.  Also during this period, we have had bouts of very sharp market corrections, triggered by a variety of events usually around spring – emerging markets, commodities and most recently sub-prime mortgages.  Each time, the damage is largely contained and the rest of the market has rebounded strongly.  Of course, this does not mean a more general meltdown is not around the corner.  But it does suggest that investors and capital flows have become more discerning, thereby reducing the risks of contagion.

12   The second factor of comfort is found in Asia countries itself, in the two channels through which the ’97 crisis was transmitted and amplified: The external sector and the banking sector.  Both look much healthier now.  For the external sector, Asian countries were running an aggregate current account deficit of US$52 billion in ’97 – about 20% of GDP.  Now they are running a surplus of US$83 billion – about 15% of GDP.  Foreign reserves are approaching US$2.3 trillion, 5 times that in ‘97.  Countries like Korea, Thailand and Indonesia have floated their currencies.  For the banking sector, improvements have also been observed.  Non-performing loans have fallen, in many cases, to below pre-crisis levels.  Prudential standards, capital adequacy and asset qualities have also improved.

13   What are the areas of concern?  I’ll name 2.  First, market data and information in Asia are still not as rich and representative as those in more developed markets.  This is simply because Asian markets have a relatively short history and are still undergoing tremendous changes.  This is not to say we cannot use the data; but we need to use them with a dose of caution and judgment – As Benjamin Graham says: “With a margin of safety”.  My concern is that in the rush for returns and the current sanguine climate, this “margin of safety” may be overlooked.  In the run-up to ’97, investors built up huge positions on the “sanctity” of currency pegs and implicit government guarantees.  Investors may do the same now, on the “sanctity” of returns, volatilities, correlations and other parameters, estimated from a fairly shallow set of historical information and experiences.

14   The second concern I have is with retail investors.  The current stock market bull run in Asia has seen a surge in retail participation.  In China, 4.7 million new stock trading accounts were opened in Jan and Feb this year.  There is nothing wrong with retail investments per se.  But to the extent that the participation may be driven by speculative fervor and herding behavior, the stock market and financial system, I believe, may become inherently less stable.

15   In short, will we see a repeat of the Asian crisis?  I believe not.  However, there is no room for complacency.  If history is any guide, no two crises are completely identical.  There are usually new weak links and risky spots that have emerged unexpectedly.  We, both regulators and market participants, have to be ever vigilant for these spots and to take the necessary precautions and measures to address them sooner rather than later.  This, I believe, is the best guard we can have against another crisis.        

On that note, I wish all of you a very enjoyable evening.