EMTA SINGAPORE FORUM
HENG SWEE KEAT DISCUSSES ASIAN BOND MARKET DEVELOPMENT AT EMTA SINGAPORE FORUM
In November, EMTA inaugurated a new series of Forums held in the Far East, sponsored by ING Wholesale Bank. EMTA’s Forum in Singapore was held on November 1, 2006 and attended by 150 market participants. The event featured a keynote address by Heng Swee Keat, Managing Director of the Monetary Authority of Singapore (MAS), as well as investor and sell-side panels. Two days later, 100 Emerging Markets professionals participated in a lunchtime Forum in Hong Kong. As a result of the interest in these events, EMTA expects to host similar forums in the Far East in 2007.
Singapore Monetary Authority Managing Director Cautions “Still a Work in Progress”
Heng’s topic was the still-youthful Asian bond market. He reminded his listeners that, before 1997, “outside of Japan, Asian domestic bonds did not exist as an asset class.” Thus, Asian corporations were forced to rely for most of their debt financing on bank loans, often in foreign currencies, which exposed them to exchange-rate risk. During the financial crisis of 1997, “the contagion spread rapidly across sectors and countries, resulting in bank failures and corporate insolvencies.”
As a response to the crisis, Heng continued, many Asian nations “built the basic infrastructure for a bond market—a robust government yield curve, a primary dealer system, public offering processes, and settlement and custody facilities.” The new markets were integrated through the Asian Bond Market Initiative (AMBI). Today, the overall market stands at US$2.7 trillion, or 45% of Asian GDP, of which US$360 billion is domestic corporate bonds.
“Have we therefore succeeded in building a vibrant Asian bond market?” asked Heng rhetorically. His answer: Not yet, characterizing it as “still a work in progress.”
Currently, government bond liquidity varies widely, from 2-3 basis points for Korea and Singapore to more than 10 basis points in Indonesia—”better than most Emerging Markets in Latin America and Eastern Europe,” Heng pointed out, but still leaving much room for improvement. Greater price transparency will support liquidity by drawing in more participants; several Asian nations are encouraging this by moving their bond markets to multilateral platforms, especially e-platforms.
Heng is in favor of the ability to sell short. “Some regulators are still wary of the whole notion,” he admitted, but he believes that “a market that has both long and short positions is deeper, and ultimately more stable, than one where everyone is long.” He also supports an active derivatives market, either in futures or in swaps. And he feels strongly that Asia “should be actively facilitating foreign participation, and integrating our markets into the global system.” To accomplish this, Heng suggested that Asia should establish a clearing and settlement mechanism, like Euroclear or DTCC; remove withholding taxes; and improve credit rating agencies for corporate bonds, both by increasing access for international agencies and encouraging local ones to be more transparent in their methodology.
Turning to future developments, Heng predicted that the Asian bond markets will collectively grow 10–15% annually over the next 10 years, bringing them to about US$10 trillion in 2015, about half the size of the US bond market. Growth will come from corporate financing needs, from the additional mortgages and consumer loans that arise from increased affluence, and from the substantial infrastructure financing needs that lie ahead. Foreign participation in bonds should also increase, declared Heng, since “foreign investments today are overly concentrated in equities.” Finally, he expects multi-market bond vehicles, such as bond mutual funds or index-linked notes, to proliferate. Heng concluded that he expects Singapore to be a key player in the burgeoning Asian bond market.
Sell-Side Panel Debates Global Economic Backdrop
EMTA’s first panel of the Forum, Prospects for the Emerging Markets, was moderated by Tim Condon of ING Wholesale Bank and included John Stuermer of Bear Stearns, Lee Boon Keng of DBS Bank, Martin Hohensee of Deutsche Bank and David Fernandez of JPMorgan.
To set the backdrop, Condon directed his co-panelists to assess the importance of the US economic condition to global credit spreads. Fernandez noted that an internal client survey at JPMorgan indicated that a slowdown in the US economy is expected, including a possible rate cut by the United States Federal Reserve Bank but stopping far short of a hard landing. Fernandez conceded, however, to a more bullish outlook than his clients, predicting GDP growth of as much as 3%. He finished by forecasting that the slowdown in the US housing market would not adversely affect the overall picture, and predicted that investors will stay in EM because US prospects, while stable, are slower.
Lee asked whether the market needed to adjust its thinking. “We sit here in Asia, but we talk a lot about the US!” he exclaimed. Concurring with Fernandez, he predicted that the Fed will indeed lower interest rates. Lee opined that the flow into Asia will be a result of a flattening of the US economy, and that the most likely play in Asia will be FX, “but there is a lot of upside potential in other asset classes.” Hohensee agreed with the other panelists that he did not see any systemic risk, and indicated his preference for credit as an asset class in the current environment.
Condon invited panelists to voice their opinions on whether spread compression was being fueled more by global liquidity or by improvements in fundamentals. Stuermer identified export consumption as the future driver of growth in Asia. He admitted to being bullish on the Philippines, but conceded that growth there is still disappointing. Turning to Thailand, he predicted 5-6% growth, and noted that the recent coup had brought stability to the country. (He quipped that Thais “do coups very, very well—it’s just elections they can’t handle!”)
Panelists Debate Ascendancy of Local Markets
Noting that “many of us have been working on local markets guides” recently, Condon asked for panelist comments on the recent drive into local market investments. Hohensee observed that he was seeing flows moving into Asian local markets now that access to them is no longer hampered. He added that his positive take on these investments was driven by the compression of local credit spreads, while noting that there is “no original sin left”.
Lee agreed with Hohensee on the attractiveness of local market investments. While “dollar bonds won’t become a collector’s item, they will probably come close to it,” he affirmed. Stuermer largely concurred with his fellow panelists, but stressed the existence of several “speed bumps on the way to Local Currency Paradise,” and predicted that dollar-denominated bonds would continue to be an important asset class for the foreseeable future.
Turning to the topic of China, Fernandez indicated that while investors are consistently bullish on Chinese growth (“the number of China bears is close to zero”), confidence in the regime is not yet universal. He added that JPMorgan’s forecast of 7.75 for the Chinese renminbi by year-end is still conceivable.
Panel Identifies Top Picks for 2007
Condon concluded the panel with a request for the speakers’ top picks for 2007. Stuermer noted he had recommended Pakistan until recent tightening, and would like to see Pakistani and Vietnamese corporate issues in 2007. Lee identified Thailand FX as his top pick for 2007, while Hohensee recommended an overweight in Asia generally, with Indonesia and Philippines as specific picks. Fernandez also chose Philippine local markets, conceding that in the current environment “he was looking for trouble and having a hard time finding it.” He added that an internal survey indicated Philippine ownership was at a four-year high, with investors willing to “experience withholding tax pain in order to get the exposure.” Moderator Condon closed out the panel with his eye on long-dated local Indonesian bonds.
Investor Panel: Positive Outlook on US Economy Spills Over Into Asia
Aaron Low (Lumen Advisors) moderated the event’s investor panel, leading off the discussion by asking speakers for their general outlook for the EM asset class, and for their opinions on how sustainable the current global background is. Tung Siew Hoong (Government of Singapore Investment Corporation) responded that he saw a positive outlook for the EM asset class, due in part to the similarly positive outlook for the US economy. Chew Soon Gek (ING Private Banking) concurred, predicting growth of 2.5 to 3% in the US, 2.7% in Japan and 2.1% in Europe, and voicing her opinion that the US Federal Reserve will suspend its rate-cutting campaign.
The Rohatyn Group’s Goetz Eggelhoefer also predicted a positive outlook for US growth, although he is concerned about US rate hikes in 2007. “However, as this is likely to be prompted by labor costs, such hikes would be associated with stronger growth” and thus not lead to a market sell-off similar to the one in May 2006, he asserted.
Importance of BRICs to other EMs Discussed
Low next solicited viewpoints on what spillover effect the popularity of the BRICs will have on the rest of the EM asset class, and whether the BRICs will be a supplementary pillar of global growth support for EM markets as US growth slows. Tung asserted that while BRICs grab headlines, there are actually more investment opportunities in local markets. Eggelhoefer noted that he was not “a subscriber to the economic de-coupling theory; the events of last spring’s sell-off bear that out as there were global ramifications.” He added that while the outlook for Asian domestic demand is positive, it would not be robust enough to act as a buffer to a slowdown in US growth.
Chew responded to Low’s next question on which country had made the most improvements in fundamentals by placing Brazil (“some expectations are so low they could be surpassed”) and Russia (“it’s come a long way”) in the forefront. Chew emphasized the potential upside to the Russian story, predicting that there will even be room for a ratings upgrade in the not-too-distant future. Specifically, she sees the corporate ends of the asset class in Russia and Brazil as offering the most value, followed by OTC plays in each.
Overview of Local Markets Promises and Challenges
The panelists then turned their attention to local bond markets in Asia, following the earlier comments of the MAS’s Heng. Low noted that liquidity is frequently an issue across the region—in EM and developed markets alike. Ng responded to Low’s question of whether the local markets were attracting a greater number of players by observing that “we expect a mix of both Asian and non-Asian investors, but we still haven’t seen a lot of interest from US participants.”
Tung predicted positive experiences with the local market EM class as a whole, noting the trend among EM sovereigns such as Brazil, Mexico and Russia to retire foreign indebtedness in order to reissue in local currency markets. He added that New York and London sell-side firms have been quicker to adapt to this change than their Asian counterparts.
Eggelhoefer concurred that local markets are the next phase of development in the EM asset class. Large pension and domestic mutual funds will create demand for duration and pressure to extend the local yield curves.
Turning to specific countries, panelists were asked to discuss whether recent progress in the Philippines and Indonesia could be sustained. Eggelhoefer professed a sanguine view of both countries. He mentioned that both governments need to press for structural reforms, remarking that at least part of Philippine performance could be attributed to Manila’s “forgetting to spend!” He praised the country’s “credible economic team” and its “improving political situation.”
As for Indonesia, Eggelhoefer noted with approval the recent reduction in government subsidies, to positive market response. He highlighted the need for labor, infrastructure and structural reforms, and expressed disappointment that they had not led to the increased foreign direct investment he had hoped for. “The Indonesian government will have to address structural reforms if they want to continue to be market darlings,” he cautioned, adding, “the jury is still out on that.” Ng seconded Eggelhoefer’s comments on the country’s need for infrastructure improvements.
Panelists Identify 2007 Picks
Rounding out the discussion, Low polled the panel for their 2007 recommendations. Tung admitted to a preference for the Turkish local market and added that his top pick in Asia for 2007 is India, based on an anticipated appreciation of the Indian rupee against the US dollar.
Chew, acknowledging a more defensive posture, said she was leaning toward investments in the Russian corporate sector—excluding the banking sector—”where you can still see double-digit returns.” She added that her favorite Asian play in 2007 will come from the long-dated Indonesian paper market.
Eggelhoefer focused instead on key themes in 2007, describing the divergent monetary policies of countries such as Indonesia (“in the forefront of rate-cutting policy”); Thailand and the Philippines (“which might be on the verge of cutting rates”); and India and South Korea (“which might not be done with their rate hikes.”) His second investment theme for 2007 is the “rebuilding of Asia”— Indonesian infrastructure projects, for example. Low added his own recommendations of equities and Turkish locals, and revealed that he is “looking at Vietnam.”
Ng indicated he would be keeping his eye on currency appreciation in Asia, particularly the Chinese renminbi, and conceded he had been surprised by the performance of the Thai baht in 2006. Local bond markets in Indonesia and the Philippines also look attractive to Ng in 2007.
Queried about risks for 2007, the panelists almost uniformly described the risk of a major market disruption in 2007 as somewhat low level. Tung and Ng pointed out that a US economic slowdown remained the most important risk to the asset class. Chew opined that the key risk to the market is greater-than-expected monetary tightening and a withdrawal of global liquidity.
Eggelhoefer did not foresee any events which could derail Asia as a whole, and thought there were enough safeguards in place to prevent a specific market event from leading to pan-Asian contagion. “We focused on election risks in Latin America earlier this year, but the ‘political theatre’ in Thailand and the Philippines proved to be more important,” he declared, surmising that domestic events might have more aftereffects than exogenous variables.