Apr 02, 2014

    Asia headed for deeper financial markets

    MAJOR international newspapers these days are littered with calls for an Asian market crash.

    China has too much corporate debt, South Korea's households are overleveraged, and political risk in Indonesia, India and Thailand is endangering much-needed reforms.

    Meanwhile, many Western banks are reporting poor results in the fixed-income business and most expect this trend to continue.

    It's a gloomy picture, but behind it is another, which has yet to come into focus.

    A picture which shows that Asia's financial markets are underdeveloped and set to massively outgrow the West.

    A picture of financial deepening, which is great news for companies, investors and the financial sector in Asia.

    The deeper a country's financial markets, the cheaper it is for governments and companies to borrow money.

    As financial products become cheaper and more plentiful, the wheels of the economy turn faster, benefiting the entire population.


    Financial deepening is a measure of a country's financial assets - stocks, bonds and loans - divided by its gross domestic product (GDP). Through this lens, it is crystal clear that Asia's financial markets are underdeveloped.

    The United States' financial depth is roughly 450 per cent - that is, US$70 trillion (S$88 trillion) worth of corporate bonds, stocks and loans over a GDP of roughly US$16 trillion.

    Asia, excluding Japan and Australia, has roughly the same GDP, but a much smaller stock of financial assets.

    The US prefers bonds over loans, and Europe the opposite, but, any way you slice it, Asia has a fraction of the financial depth of the West. The difference is most striking in corporate bonds, where Asia, excluding Japan and Australia, has only US$4.7 trillion outstanding, against US$22.4 trillion and US$17.5 trillion in the US and Europe, respectively.

    Companies in Asia rely too much on banks for their funding, and those with wealth have little choice but to put their savings into real estate, gold, less developed equity markets or bank deposits.

    It's a Catch-22: Companies in Asia can't issue as many bonds as they'd like because there isn't enough local demand, and investors aren't buying Asian bonds because the markets are not yet as deep and liquid as in the West.

    There is also another kind of financial deepening occurring in Asia - an extension of growing capital markets in the form of instruments that enable risk transfer within the financial system, namely foreign exchange, futures and derivatives.

    Foreign exchange is already a hugely important instrument for Asia - much more so than in the US since the dollar is currently the No. 1 global reserve currency.

    As for futures and derivatives, Asia has only a fraction of those of the West, but these instruments will grow substantially in Asia as more companies hedge their exposures to commodities, interest rates and foreign exchange, and as more wealth becomes managed by professional investment managers.

    We believe Asia is about to reach a tipping point where issuers and investors will increase their appetite for bonds and the use of derivatives will increase, enabling a more efficient transfer of risk within the financial system.

    Asian regulators are speeding this along by introducing more prudent forms of financial evolution, such as new and better benchmarks, and by widening the range of financial products available to investors.

    All this will create a virtuous circle, as companies get more options for raising funds, and individuals and institutions more options for saving and investment, increasing the resilience of the financial sector in Asia.

    We estimate that, by 2017, the corporate bond market in Asia, excluding Japan and Australia, will grow significantly to reach more than US$10 trillion, accounting for 40 per cent of the corporate funding mix, up from 28 per cent in 2012.


    While in the West, financial markets arguably overdeveloped in the boom years - as was highlighted painfully by the financial crisis - Asia, in our view, still has significant scope for financial deepening.

    What's more, it has an opportunity to learn from the excesses of the West, creating deep and resilient financial markets that are capable of supporting the needs of the real economy for the long term.


    The writer is group head, financial markets, at Standard Chartered Bank. This piece first appeared in The Business Times.