Why the Asean dream is still just that

Euromoney, September 2011

Cesar Purisima is in full flow. The Philippines finance secretary is sitting in a cavernous Hanoi conference centre at the Asian Development Bank annual meeting and is talking up his country’s prospects in the light of a unified southeast Asia. “We are really bullish looking to the future of an integrated Asean,” he says, as images of idyllic Boracay beaches and the rolling chocolate hills of Bohol drift past on a TV monitor behind him, a pitch to attract more intra-Asian tourism to the Philippines. “Asean is an economy of 600 million people, a very favourable demographic, and the Philippines is very well positioned to actively participate in that.”

Purisima is doing something that more and more people in this region tend to do: speak of Asean as a single economic bloc. It’s a compelling case. A combined Asean economy would, UBS says, be the sixth largest economy in the world.

There’s just one problem with this unified vision: it hasn’t happened. It’s not even close to happening.

The Association of Southeast Asian Nations brings together 10 nation states embracing a greater variety of wealth, society and political process than could be found almost anywhere else in the world. Free-market, first-world Singapore has about as much in common with isolationist Myanmar (Burma) as the USA does with Bolivia. Oil-rich Muslim prefecture Brunei and impoverished, communist Laos might have some passing relationship in terms of geography and flora, but certainly not in economy, language, politics, religion or culture. Indonesia’s economy is 118 times bigger than that of Laos, and its population almost 600 times greater than Brunei’s. The 10 member states occupy a span of 141 rungs on the World Bank per capita GDP ranking, a greater range than the entire African continent.

“We are some distance away from Asean being an economic bloc,” says Taimur Baig, a chief economist at Deutsche Bank. “They are not homogenous economies, and not even comparable in many regards. Some are resource economies, like Malaysia and Indonesia; some are based more on electronics trade, like the Philippines or Thailand; even in terms of political systems, they are very different.”

Still, the fact that it’s not there yet doesn’t mean that progress cannot be made: as recently as 20 years ago, the idea that Portugal and Estonia might one day share the same currency would have been preposterous. “Asean is clearly not a single bloc now,” says Edward Teather, economist at UBS in Singapore. “There are barriers between countries in movement of capital, movement of labour, movement of ideas. But it’s precisely because you can move towards breaking those barriers down that opportunities are created.”

SUBHEAD: TRADE AND 2015

Asean came into being in 1967 in Bangkok, amid the Vietnam war, with a mandate to accelerate economic growth, social progress, cultural development and stability through the region with collaboration and mutual assistance. While it has expanded over time, its five original member states of Indonesia, Malaysia, the Philippines, Singapore and Thailand remain its core today. It has never really been a political or economic powerhouse, and didn’t even have legal form in its own right until 2008, but has nevertheless had a few milestones along the way, chiefly the signing of a free trade agreement in 1992, the Chiang Mai initiative of bilateral swap agreements in March 2000, and the formal introduction of broader FTAs (both intra-region and between Asean and China) from January 2010.

Asean’s biggest moment – and the closest thing to the unified Asean that some envisage – is due to happen in 2015, when the Asean Economic Community is created. This would involve free movement of goods, services, investment and skilled labour, and in theory a freer flow of capital – although this, discussed below, may be the trickiest part of all.

Economists quite like the idea: Teather at UBS argues that progress towards a single market should enhance growth prospects across the region, and will also spur infrastructure development and more cross-border M&A. It’s particularly appealing at a time when so much of the rest of the world is a mess (although Asean in aggregate would actually be very heavily exposed to the world economy, with one of the world’s highest export to GDP ratios). “What’s envisaged is a pretty big deal,” Teather says. “It would allow a spread of ideas across the region. That matters because there is such a divergence between Cambodia and Laos, for example, and Singapore: if you can bring capital skills ideas into those poorer countries, you could potentially make a huge difference to how those millions of people see their incomes grow in future.”

But right now, it’s interesting to note that, as Teather puts it, “Asean in aggregate has strong links with the rest of the world but less so with itself.” Only 25% of total Asean economy trade is with other Asean economies, he says, far lower than internal free trade within the European Union or NAFTA.

Anecdotally, people think this is changing – and in particular the need for trade to go in and out of Singapore, as it always used to, is declining. Purisima, for example, says the Philippine electronics industry has already been bolstered by integration. “Moving products from Manila to Penang to Singapore is like moving it from Chicago to the Silicon Valley,” he says. “It’s all efficient now. That’s going to be the strength of Asean integration.” Some analysts see improvements in regional activity too. “There is a lot of political chatter but the important point is businesses are moving together with to without agreements on free trade integration,” says Tai Hui at Standard Chartered.

But there’s clearly a long way to go. “There will be considerable transitional requirements” between now and 2015, says Baig. “It’s not just a question of unified visa-free travel or a removal of trade barriers. There will need to be far more advanced arrangements as far as customs, trade agreements and labour movement are concerned.”

There are also some questions about commitment. For example, the Asean Investment Fund is being established right now, probably with initial capital of US$500-800 million. Compare this with the US$80 billion the European Commission put to work to enhance growth and employment within the EU, or the US$596 billion the ADB has calculated is needed in capital for a better Asean transportation network between 2006 and 2015, according to UBS. Partly reflects the fact that the investment that brings Asean together, if it comes, will be from local money, not from some major supranational: Asean is only really there for coordination and doesn’t have a great deal of institutional heft (as anyone who has tried to get its Jakarta-based secretariat to respond to a phone call or email might attest).

The infrastructure side of it has a lot of foreigners interested. Various plans flourish and fade from time to time: a pan-Asean highway network; a Singapore-Vietnam-Kunming rail link, or another from Kunming to Laos and Bangkok; an Asean power grid, or a Trans-Asean gas pipeline. 2015 harmonisation might make it easier for projects like these to get underway, with all the knock-on effects that infrastructure development provides. This is a crucial point: progress in infrastructure development, and in particular private sector involvement, is seen as the weakest link in national circumstances from Indonesia to the Philippines and beyond.

SUBHEAD: THE CAPITAL QUESTION

The roadmap for 2015 includes a commitment to freer flow of capital: greater harmonization of financial security rules, mutual recognition of market professionals, a broader investor base with managed withholding tax issues, and market-driven efforts to establish exchange and debt market linkages.

And this flow of capital is perhaps the single most important point. Because if Asean doesn’t meaningfully exist as a trading bloc, it most certainly doesn’t exist as a single pool of liquidity. Southeast Asian nations have some of the highest savings rates anywhere in the world, but if those savings are ever invested cross-border, they don’t go into Asean neighbours; they fly into dollar assets. “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, a senior economist with the Asian Development Bank’s Office of Regional Economic Integration.

It should be said first that since the Asian financial crisis – when Alan Greenspan said Asia didn’t have a spare tyre, in reference to the lack of local bonds – the region’s local currency debt markets have improved out of sight in terms of their scale, maturity and sophistication. Currency mismatches that blighted Asia in the late 1990s have been significantly alleviated by the availability of local funding in the same currency as an issuer’s liabilities; in the Philippines, for example, the state can raise funds at maturities out to 25 years (making infrastructure financing feasible in a way it never was before), while in the middle of the global financial crisis San Miguel Corporation was able to raise Ps38.3 billion (US$800 million) entirely from local markets at a time when G3 markets had shut down.

But the problem is not local market development, but an absolute lack of coordination among them so that they can attract funds from their neighbours. “Capital markets integration is much further away than on the trade front,” says Dato’ Lee Kok Kwan, Deputy CEO at CIMB, the Malaysian bank which is a rare example of an attempt to build a pan-Asean presence in local financial services. “Cross-border in Asean means US dollars. 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. The question is, why can’t Asean + 3 invest in itself and instead require foreign fund managers to do it for us?”

Various initiatives have been started to try to improve things. The ADB has been behind many of them, notably the Asian Bond Market Initiative, launched in 2003 to help local bond markets to grow and develop integration between them. Among other things, this initiative tries to promote more local currency issuance, improves regulatory frameworks, tries to harmonize rules around the region, and looks for ways to boost liquidity. It also hosts the Asian Bond Market Forum, which is designed to bring the private sector into these initiatives, and publishes data sources such as AsianBondsOnline.

Another initiative is the Asean Capital Markets Forum, made up of Asean regulators and formed in 2004. In 2009 this group endorsed something called the Asean Plus Standards Scheme, which aims to set capital market disclosure standards for cross-border offerings of securities. The idea is that if an issuer makes a multi-jurisdiction offering in Asean, they can use common disclosure standards as well as whatever additional requirements each individual market requires (that’s the ‘plus’ bit). The ACMF is also in charge of a roadmap to implement the capital markets elements of Asean’s 2015 economic community blueprint.

Then there are the Asia Bond Funds, launched by the Executives’ Meeting of East Asia-Pacific Central Banks (EMEAP), made up of the central banks of 11 economies including most Asean states. Its first US$1 billion fund, launched in 2003, invested in dollar denominated bonds from Asian sovereigns and quasi-sovereigns; a second, with $2 billion in 2004, created a pan-Asian bond index fund and eight single market funds in Asian local currencies, to allow investors to get diversified exposure to Asian bond markets. There is much discussion in the region about what a third Asian Bond Fund would look like, with a growing belief that it should focus on investing cross-border in primary and secondary local currency bond markets. “ABF2 has done its job very well, but that job – buying local currency bonds – is done and dusted,” says Lee. “The market’s come a long way. The next big jump is into cross-border issuances and cross border investing. That should be its macro objective.”

On top of that, various bilateral deals have been struck; and there is the Chiang Mai initiative, which created a US$120 billion pool of foreign exchange reserves to preserve currency stability and liquidity in the region.

Market regulators in Asean sound keen. “We are very much at the forefront of the integration of Asean capital markets,” says Tan Sri Zarinah Anwar, Chairman of the Securities Commission of Malaysia. “But when we talk about integration, we’re not really talking about one single market, but more in terms of enabling access to each other’s market.” She is involved in harmonising debt rules around cross-border transactions, and is assisting the development of direct access between Singapore, Malaysia, Thailand and the Philippines’ stock markets, for example, “but without bypassing or marginalising domestic intermediaries:  a very important consideration that has to be taken into account when integration takes place.”

The qualifier Zarinah adds is interesting, because it suggests there’s a potential downside to integration: the potential erosion of domestic financial services. She’s not the only one who sees it. “Integration must be carefully designed,” says Nurhaida, chair of Bapepam, the Indonesian market regulator (like many Indonesians she goes by just one name). “The various initiatives being put forward at the Asean level try to improve on the current eco-system,” she says, but in some cases with side-effects: a proposal for a linkage among central depositaries, for example, would “kill domestic custodian institutions.”

SUBHEAD: BECOMING A SAFE HAVEN

Perhaps greater integration, or better credit ratings (see box), would help with a very annoying problem. From any rational perspective of sovereign debt and other fiscal indicators, Asian nations should be seen as safe assets. But whenever the world economy wobbles, capital tends to flee Asia, and go back to the US and Europe – precisely the places that have generally caused those wobbles in the first place.

When does Asia become the safe haven? “To some extent, it has already happened,” says Neeraj Seth, managing director and head of Asian credit at BlackRock. “You see it more in fixed income than equities, which have been more volatile; in bonds the capital flow in Asia has been consistent and positive, and I do believe over the long term it will continue. The only risk is in the short to medium term there could be small patches of reversal.”

But these short term reversals remain considerable, and this is something that keeps finance ministry and central bank officials awake at night in Jakarta, knowing that 35% of rupiah government bonds are now held by foreigners who could in theory disappear at any time. In equities, it’s worse still.

Fund managers think the long term answer to this is the development of significant institutional investors. “I would expect the Asian stock markets to continue to be higher volatility, because they are still the marginal stock markets in global equity portfolios,” says Kerry Series, founder of 8 Investment Partners, an Asia-focused fund manager in Sydney and a great believer in the long-term outperformance of Asian equities. “Asia Pac is only 6% of the MSCI developed world index. When investors change their attitude to risk, it’s going to be marginal stock markets that perform better or worse. And Asia is only now developing the institutional investment structures that underpin long-term investment in markets.”

And perhaps this is the most crucial point of all: when Asian pension funds, insurers and other institutional investors reach meaningful size, as they inevitably one day will, this could potentially be the tipping point that has been missing from Asean. It will lead to stability of markets and capital flows, and to the establishment of sensible long-term investors with the ability to look closer than the dollar markets and instead see opportunity in their near neighbours. “The creation of local pension funds is just at its beginning in some countries, especially in Indonesia and the Philippines,” says Sitohang. “But as they become more established and institutionalized, that counterbalance of local money filling the gap left by foreign capital flight is going to get more and more powerful.”

There are those who feel that for 20 years Southeast Asia has promised a lot and failed to deliver. But the truth is it, and Indonesia in particular, is the world’s bright spot today: low debt, high growth, demographically well placed. “Southeast Asia has already been through the issues plaguing the rest of the world now,” says Teather. Maybe this time, at least, it can steal a march on the rest of the world.

BOX: THE CURRENCY IDEA

If a single currency in Asean looked far-fetched before, it looks positively absurd in light of the stresses afflicting the euro zone today. “I think Asean leaders are watching what’s happening in Europe extremely carefully now,” says Helman Sitohang at Creit Suisse. “It may provide some good lessons about how far you should push cooperation and integration.”

A single currency is not on the agenda. You won’t find it in the long-term visions of Asean mission statements or ADB ambitions. But actually, is it so strange an idea?

Edward Teather at UBS points out that if you were to look at the ratio of the Thai baht to the Malaysian ringgit prior to the Asian financial crisis, and again today, it would be pretty much the same: around 10 times. “There is a linkage there, though it is not explicit in any way,” he says. “Southeast Asian central banks and countries like to make sure their currencies don’t appreciate suddenly and in a fashion that renders their exports uncompetitive.”

Not all cross-rates follow this rule, but they’re generally pretty close. Asean currencies have, pretty much en masse, appreciated against the euro and dollar; they have also behaved in concert against resource currencies like the Australian dollar and the Swiss franc.

“From a de facto exchange rate regime, how big a step is that?” asks Teather. “It’s not such a pie in the sky idea as you might think.”

BOX: RATING AGENCIES

Asean is one of the few regions of the world where the talk is not of downgrades, but of upgrades. Mostly, this is about Indonesia, where all three international rating agencies have Indonesia just one notch below investment grade, with a positive outlook; most analysts expect Indonesia to be upgraded by at least one of them by the end of the year (the smart money’s on Fitch), and probably all three within 12 months or so. The Philippines, too, is on the right track, with Finance Secretary Cesar Purisima on a personal crusade to get a ratings upgrade (the country is BB+ at Fitch, one notch lower elsewhere) in recognition of the undeniably impressive reductions being made to the budget deficit. “As our debt to GDP goes down, it creates more fiscal space for additional investment,” says Purisima. “When you do that, you get into a more virtuous circle. Our hope is that will be rewarded with an upgrade to investment grade: the market is already rewarding us by allowing us to borrow at close to investment grade prices. Our CDS prices are tighter in some cases than our friends in Indonesia.”

But there is another question about sovereign ratings in Asia: have they been getting a raw deal?

One person who is certain they have is Dato’ Lee Kok Kwan, Deputy CEO of CIMB. “There are real problems with international rating agencies,” he says. “They do not reflect credit risk in this region. Leverage is low; savings rates are high; governments are in strong fiscal positions; and you can see both cash spread prices and CDS prices for credits in this part of the world that trade way better than their international ratings.”

His particular complaint is with the sovereign rating system, which then affects the entire Asian corporate world because of the sovereign ceiling. Ratings agencies tend to include measurements such as media freedom, or right to free assembly, within their assessments. “What’s that got to do with the probability of default?” Lee says. “Thailand has $700 million of total foreign currency debt, supported by $160 billion of reserves. Its debt is almost zero and its local currency bonds are so popular it can’t issue enough to satisfy domestic demand. Its savings rates are about 30%.” Yet Thailand, at BBB+ from Standard & Poor’s, Baa1 at Moody’s and BBB at Fitch, is rated considerably below troubled European sovereigns Italy (A+, Aa2, AA-), Spain (AA, Aa2, AA+), and on a par with Ireland (BBB+, Ba1, BBB+).

Some internationals think he may be on to something. “Standard & Poor’s sent their report to the US treasury before it was published?” says Kelvin Tay, strategist at UBS. “In this part of the world there is no pressure on that front: Asian governments have no leverage over ratings agencies. But the flipside is, the transparency on getting numbers, hard data, is a lot more difficult here.”

It will be interesting to watch the development of Dagong, the Beijing-based international credit rating agency; already some Asian states appear to think it a more tuned-in, relatable voice in Asia. In truth the ratings aren’t actually that different:  Dagong has Malaysia at A+, Thailand at BB, the Philippines at B+ and Indonesia at BBB-, in line with international standards (and in the Philippines case, worse). But it is harder on Spain, for example, which it rates A.

One subject that often comes up allows for a greater role for local, home-grown ratings agencies, such as TRIS Rating in Thailand, Rating Agency Malaysia (RAM) and Malaysian Rating Corporation (MARC) in Malaysia, Pefindo in Indonesia and MARC in Malaysia. Generally, there is no mutual recognition of one another’s ratings cross border, which is one of the many impediments to integration of bond markets, whether from an issuer or an investor perspective. “If you are going to expand the market in the region then there’s got to be guidance for investors to look at in terms of the credit standing of different issuers in the region,” says Amando Tetangco, Governor of Bangko Sentral ng Pilipinas, the Philippines central bank.

From time to time people suggest a single credit rating for Asia, but the idea does not seem to have caught on, and in some quarters triggers outright indifference. Nurhaida, the chair of Indonesian capital markets regulator Bapepam, was asked about the regional agency idea by Euromoney in April. It is, she said, “something which I find amusing.”

BOX: Governance: has anything changed?

In July, a Boeing 737 belonging to Thailand’s crown prince touched down at Munich airport. It was to stay there considerably longer than planned. German authorities, upon realising who owned the plane, seized it in connection with a long-standing payment dispute between a failed German construction group, Walter Bau, and the Thai state, which insolvency administrators claim owe it more than Eu30 million – the reason the company went under in 2005.

The dispute dated back 20 years, to the construction of a road between Bangkok and its airport. Thailand never paid and the Thais have long since refused to respond to claims for the money.

The plane has since been released – so somebody’s presumably paid surety – but the incident recalled a pre-Asian crisis, fast-and-loose era of bad governance and questionable creditworthiness, long gone. Or is it? How much has Asian governance really changed?

The accepted barometer of corporate governance standards is the Asian Corporate Governance Association and its CG Watch publication, produced in conjunction with CLSA. “Corporate governance standards have improved over the past decade, but even the best Asian markets remain far from international best practice,” began its 2010 report, bemoaning that regulators make it too easy for companies to get away with box-ticking, markets lack effective rules on governance, and institutional investors generally don’t do enough to push for reform. “Rather than use the global financial crisis as a platform to push reform forward, governments have taken a complacent view, happy that the crisis this time did not start in Asia.”

Jamie Allen, ACGA’s Secretary General and the driver of the report, sees a mixed bag around the region. Singapore, he notes, has moved ahead on a number of issues, including company law amendments, voting methods in shareholder meetings, and appointments of proxies. Thailand has improved from a regulatory perspective, but the change of government – led by the sister of the deposed and convicted Thaksin Shinawatra – raises questions. Malaysia has just unveiled a wide-ranging new corporate governance code, which is clearly positive, and there is progress in Indonesia. “There are lots of difficulties there and I don’t want to overstate the case for Indonesia,” Allen says. “But we did feel that in terms of what companies, the government, Bapepam are doing, their efforts were more thought out and better organised than the Philippines.”

The Philippines dropped to last in the 2010 ranking, which didn’t go down particularly well – chiefly, it is understood, because they couldn’t believe they were worse than Indonesia. “The Philippine government doesn’t support the securities commission; there are real governance issues on the stock exchange, where brokers still dominate the board; we found cases where major companies were breaking listing rules and there didn’t seem to be any enforcement. There’s just the whole level of corruption in the Philippines: it’s bad in Indonesia, but at least they’re trying to do something about it there.” ACGA’s latest report chiefly reflected practice under the previous administration; it remains to be seen if the Aquino government, which built a large chunk of its entire electoral platform on ending corruption, can make a difference.