Asean +3 bond market handbook 2: savings patterns

Emerging Markets Asean + 3 bond market handbook

Chapter 2: Savings patterns

Asia is the engine of world growth, the source of voluminous savings and the home of the biggest foreign exchange reserves in the world. Why, then, does so much of the money that comes from this extraordinary economic growth story not stay here but go into US and European markets?

There is a peerless volume of savings being generated for investment in this region, which ought to provide fuel for local market development. “In general, the savings patterns in Asia are quite different from those in Europe and North America,” says Li at the HKMA. “In Asia people tend to save up more than they spend.” Yet if the funds leave home, they go a long way from home, usually all the way to America.

Consider the region’s sovereign wealth funds. The Government of Singapore Investment Corporation had only 24% of its portfolio in Asia as of March 31 2010, compared to 43% in the Americas and 30% in Europe – and of that 24, 11% was Japan rather than developing Asian markets. The Hong Kong Monetary Authority’s Exchange Fund – about half of which is run as a sovereign investment fund, with the rest used to back up Hong Kong’s monetary base – is managed against a benchmark which is 86% made up of the US dollar or currencies that are pegged to it. The Korea Investment Corporation’s bond holdings are benchmarked against, and roughly track, the Barclays Capital Global Aggregate Bond Index, which is weighted almost 40% to the US dollar and a further 27.5% to the euro (with yen, pounds, Canadian and Australian dollars, Swiss francs and currencies from Sweden, Denmark, Mexico, Poland and South Africa all ranking higher than the currencies of Taiwan, Malaysia or Thailand.) And at the China Investment Corporation, just 28.4% of equities holdings are in Asia – the debt figure, not disclosed, is very likely much less. Only Temasek, in Singapore, really seems to believe in keeping money in the region, with a target of 70% of assets being either in Singapore or elsewhere in Asia – but Temasek invests little in the bond markets.

Sovereign fund behaviour tends to be mirrored in the broader population. People save money and either keep it local or, if they venture cross-border, go all the way to G3 markets rather than elsewhere in their own region. “There is a lot of work to do, especially at the regional level, to make sure the region’s savings are increasingly intermediated through the local markets, not the global markets,” says Sabyasachi Mitra at the ADB.

Dato’ Lee Kok Kwan, Deputy CEO at CIMB, finds this a troubling situation. “From our perspective, the main weakness in the Asean+3 bond markets today is that, while most of the individual debt markets are reasonably well developed, they very seldom invest cross border into each other. Instead, cross-border means USD markets,” he says. This has remained the case even in the last two years when international money has flocked into Asean + 3 local currency debt. “The excess savings in Asean are invested in the lowest yielding assets – US Treasuries – and then reinvested by western funds into high growth economies such as Asean+3.” When they do so, they charge generous credit spreads driven by depressed credit ratings in Asia. “The question is, why can’t Asean + 3 invest in itself and instead require foreign fund managers to do it for us?”

Lee is not calling for a revolution in investment patterns. “On the local currency front, the majority of demand will always be domestic due to the very high savings rates in this part of the world.” He expects domestic demand will always account for 70-80% of issuance. But he would like to see corporate issuers market cross-border to their peers.

The current arrangement, while illogical but inefficient, reflects the way that capital and trade behaves. “In Asean + 3, intra-regional trade is growing very rapidly and volumes today are already very large,” says Lee. “However the FX settlement for intra-Asean+3 trade is not in the Asian time zone but has to extend into the US banking hours since the region’s FX still crosses through USD. This results in settlement risks.”

Central banks are trying to establish more direct crosses, but the dollar does remain remarkably powerful. One only has to look at the composition of foreign exchange holdings – China’s US$2.8 trillion equivalent is chiefly in US dollars – to see this illustrated. “FX reserves are denominated in holdings of US treasuries,” Lee says. “But for Asean +3 governments, what makes economic and commercial sense? Buying RMB bonds, Baht government bonds, Ringgit government bonds, Rupiah government bonds, Won government bonds, at comparable or higher yields with a stronger currency outlook? The central banks are already taking some leadership role on this.”

Going through dollars creates other curiosities too: it introduces dollar benchmarks, which are not necessarily the most appropriate. And capital flows in and out of emerging markets can be destabilizing since they often tend to be fickle at times of geopolitical uncertainty. A Monetary Authority of Singapore spokesperson says local market development is “especially critical given the current bifurcated state of growth between emerging markets and developed markets that is directing more capital towards emerging markets than their capital markets can efficiently intermediate.  The key task at hand is to channel capital inflows into more productive longer-term investments such as infrastructure so as to minimize the need for short-term measures to deal with sudden outflows.”

The movement of money from the region is also strange because it is at odds with the way international money is behaving. “A lot of global savings are seeking an investment home in these markets,” says Monish Tahilramani, deputy head of global markets and head of regional trading at HSBC, highlighting foreign holdings in domestic government bonds in Korea (15%), Malaysia (25%) and Indonesia (30%), compared to 4-5%, 13% and 18% three years ago. “I would say that has been more of a standout theme than domestic savings.” While it’s hard to pin down, the sense is that this is mainly global rather than regional capital.

The impediments to greater Asian participation in its own markets are the subject of much of the rest of the book, but Amando Tetangco, Governor of Bangko Sentral ng Pilipinas, the Philippine central bank, sums up the situation for many. “The bond market is, to me, an important avenue for savings,” says Tetangco. “But for banks, large corporates and high net worth individuals, a significant amount of their savings will still be outside the country. In general [local] markets have been characterized as fragmented and relatively illiquid. So funds are invested outside the region, and then brought back in the form of investments by those institutions that had the savings in the first place.”

But at the same time, there is a recognition that savings patterns must inevitably change in Asia. “I think we are recognizing the fact that, over time, exchange controls that currently prevent the outflow of investment will have to come down,” says Khun Thirachai, at the SEC in Thailand. “Countries will be flush with cash, it will just keep piling up, and the best way is to encourage citizens to invest outward more and more.”

Various regulators and central banks have tried their own methods to keep savings local, or at least change the way in which they appear to leave. Regional initiatives are discussed in Chapter 5, but an interesting position was taken by the Monetary Authority of Singapore, which established its AAA-SGD debt securities framework in 2009. Under this framework, securities issued by AAA-rated entities are accepted as collateral and qualify as regulatory liquid assets like Singapore government securities. Since that happened, issuers such as the World Bank, KfW Bankengruppe, International Finance Corp and International Bank for Reconstruction & Development have all issued in Singapore dollars. “The framework increased the availability of high-grade liquid assets for financial institutions and improved financial stability,” says a MAS spokesperson. “In addition, surplus savings and investments could also be recycled overseas efficiently.”

Both the MAS and Malaysia’s Securities Commission have also introduced measures to help retail participation in the bond markets. But while this will help channel retail funds into local debt, and hence not US dollar or euro-denominated securities, it won’t make any difference to savings going cross-border into other Asean+3 nations. For that, greater integration between the markets will be needed, and as the next two chapters explain, that comes with numerous challenges. There is, though, a widespread acceptance of the benefits of it happening. “We certainly sense a lot of recognition of the macro problem,” says Lee. “Asean + 3 countries deploying excess savings into US dollars and rechanneling them back here charging high credit spreads or rich risk premiums in the equity markets. The question is how to solve the issue of enabling it to stay in the region.”

“The logic and commercial basis and economic need for Asean +3 is very clear,” Lee adds. “It’s just how to achieve it. The sad reality today is that global fund managers know Asean + 3 much better than we know ourselves.”