Administrations across Asia seem to be prioritising financial sector reform to assist this. Growth is no longer a consequence of globalisation but instead is being sparked from within as populations are approaching middle class status and driving change. Research suggests that Asia will account for two-thirds of the world’s middle class citizens by 2030.
As wealthy Asians reach their peak earnings years, they have a greater need for trustworthy, efficient capital markets to help them save for retirement. To serve these needs, insurance companies and pension funds require a healthy return with a measure of security to cover their long-term liabilities. Financial product advancement generates additional investment and increases demand among investors. This requires deep capital markets; so it is essential that small- and medium-sized enterprises (SMEs) have wider access to capital to invest more toward future growth, enhancing economic growth and encouraging further investment.
Growth is increasingly being driven by SMEs, instead of by conglomerates closely tied to the state. The combination of increased wealth, more sophisticated investment ability and deepening markets creates a groundswell, not only generating interest among domestic and regional investors, but creating greater assurance among foreign investors.
Private equity has provided new sources of financing for some firms. The market in China has been particularly strong where more deals are generated domestically and the investor base is growing from within. With over a million millionaires in China, high net-worth individuals are looking for avenues in which to invest their wealth. Because equities can be bought and sold at any time at a low cost they are a highly liquid diversification opportunity. Equity markets in Asia Pacific compose approximately 32% of the world’s market-capitalization, up from less than 20% 15 years ago. Much of this growth has been due to privatisations of State-Owned Enterprises and private company IPOs. Interest is rising in these markets from foreign investors and foreign institutions listing on Asia’s regional exchanges. Larger trading volumes, higher liquidity and ongoing market liberalisation have prompted firms to seek funding in Asia.
The growth of Asia’s local currency (LCY) bond markets is one of the region’s most important capital market developments representing over 31.7% of all new global bond issues (YE 2013). While some express concerns over a rapid rise in leverage, Asia is coming off a low base.
Relatively low sovereign debt levels are positive, providing local governments with flexibility in managing fiscal balance sheets. But on the private side, higher levels of debt may be considered positive, especially when the debt is held in relatively low-cost fixed income securities. A bond market’s stage of maturity can be measured in terms of its size relative to GDP. Based on this measure, South Korea, Malaysia, Singapore and Thailand rank among the region’s more developed local bond markets. In terms of absolute size, however, China dominates the region but the country still maintains a relatively low ratio of LCY bond market to GDP indicating there is still ample room for growth.
Because of disparities in liquidity and transparency between public and private sector bonds, foreign investors continue to invest in government bonds in Asia. We expect transparency improvements and increased financial market integration, particularly out of ASEAN, to promote secondary market activity. This would further build momentum for corporate issues.
So what other elements need to fall into place so that the providers of capital and the seekers of capital can gain comfort, thereby creating a virtuous cycle of liquidity in this region? In the past, Asia’s stock markets have been small and thus vulnerable to economic or financial shocks. The lack of bond markets exacerbated the problem. When stocks fall into decline, bond markets provide an alternative source of liquidity for investors and companies—but in Asia both markets have been shallow, and thus vulnerable, to external shocks.
Broad and consistent local participation may provide a floor of capital, leaving markets less vulnerable to the herd mentality of foreign investors. While they will still be subject to currency and interest rate shifts, foreign investors should take comfort in the self-sustaining feedback loop taking place in these markets. For the first time, this is being driven by domestic markets, by regional interdependence, and, consequently, by an increasingly international market that appears to view the space as a core business destination and investment strategy.