Hitting the sweet spot

The casual observer does not have to look far to see South-East Asia’s rising importance to global capital markets.

Equity capital markets are a good starting point. While uncertainty last year over China’s economy kept Hong Kong volumes down, South-East Asian issuers were busy attracting international investors to some of the world’s biggest deals of 2012.

The region accounted for 33% of the 2012 IPO market in the Asia Pacific, excluding Japan. Malaysia alone accounted for 19% of new listing volume, thanks to jumbo IPOs from the likes of IHH Healthcare and Felda Global Ventures.

While that pace in Malaysia may prove unsustainable in an election year, the success of so many fundraisings in 2012 was no accident. Stable growth projections are luring global investors to South-East Asia.

While Europe and the US struggle to stay out of recession, South-East Asia is in growth mode. Malaysia beat expectations with year-on-year GDP growth of 6.4% in the fourth quarter of 2012, while Thailand’s GDP rose 19%, which was even bigger than the large rebound expected after the previous year’s floods.

Deutsche Bank economist Taimur Baig has said the current situation is a “sweet spot” for the region.

“Driven by sustained strength in domestic demand and an ongoing pick-up in exports, ASEAN [Association of South-East Asian Nations] economies have stepped into 2013 with substantial tailwind. Monetary conditions are accommodative, fiscal policies are pro-growth, political risks seem to be stable or abating, and capital inflows are healthy,” he said.

“Little wonder that consumer and business confidence readings are at cyclical highs. Economies in the region, by and large, look comfortable,” Baig added.

Surinder Kathpalia, Standard & Poor’s managing director for ASEAN region, agrees. “The economic outlook for ASEAN remains relatively bright, especially in light of the difficulties facing other parts of the world. We forecast real GDP growth of 4%–6% for South-East Asia’s major economies of Indonesia, Malaysia, the Philippines, Singapore, Thailand, and Vietnam in both 2013 and 2014,” Kathpalia said.

Efforts to improve liquidity across South-East Asia’s traditionally thinly traded equity markets have also begun to pay off, and big deals from Thailand to the Philippines are also helping boost the region’s relevance. The pipeline of transactions for 2013 is strong.

In a record year for issues of bonds in US dollars, South-East Asia’s local currency markets also performed well. Singapore, in particular, emerged as a market capable of attracting global issuers and supporting new products.

Bond sales last year in Singapore dollars touched S$30bn (US$24bn), up more than 50% year on year, while Malaysia’s ringgit market volumes were up 25% year on year at M$74bn (US$24bn).

International investors are also taking note. Foreign investors increased their share of local currency government debt markets in 2012 in Malaysia, Thailand and Indonesia, according the Asian Development Bank.

Investment banks, likewise, are responding. Global firms from Goldman Sachs to JP Morgan are diverting more resources to Singapore in order to benefit from the region’s expansion. Goldman relocated ECM banker Steve Barg to Singapore last year, while JP Morgan is expanding its coverage of high-yield bond issuers in the ASEAN region.

At the end of last month, Barclays named Anand Ramachandran to a new position as head of ASEAN equity research, charged with leading its expansion into covering South-East Asian stocks.

Appetite for acquisitions

This influx of advisers and analysts is making the region’s financial markets deeper and more diverse. Global players, however, know they are at a disadvantage. Home-grown champions are expanding on the back of strong credit growth and investment banking revenues, which are driving record profits and fuelling appetite for acquisitions.

DBS, which has previously looked to Greater China for expansion, made 9% of its 2012 group income from South and South-East Asia and intends to grow that figure substantially if and when its purchase of Indonesian lender Bank Danamon is approved.

The S$6.2bn acquisition of a 67% stake in Danamon, which regulators have held up since April 2012, will make Indonesia one of the Singapore lender’s top three revenue markets.

Malaysia’s Maybank recorded 30% of group profit for 2012 from outside its home country, with Singapore and Indonesia contributing strongly. Loan growth in Indonesia was a healthy 20.8%, almost twice the 11.8% in the group’s home market. Indonesia also led deposit growth, with a 22.3% rise versus 8.5% in Malaysia.

“We intend to raise the tempo in our regionalisation agenda, not only by leveraging on opportunities in existing markets but also in looking for new avenues, where we can build a franchise,” said Maybank President and CEO Dato’ Sri Abdul Wahid Omar in the February 21 results statement.

Banks are expanding into the Philippines, too.

India’s Religare in March announced it had received a representative licence from the Philippines securities regulator and planned to expand its equity markets and financing businesses in the country.

“Religare Capital Markets’ latest expansion is a logical extension of the work we have been doing for our clients in the Philippines,” said Sutha Kandiah, head of investment banking. “We’ve seen the volume of transactions we handle for them increase in tandem with the growth of the Philippines economy.”

CIMB agreed to acquire a controlling stake in the Philippines’ Bank of Commerce last year for Ps12.2bn (US$300m) and has tapped an experienced investment banker, the former Credit Suisse country head Simon Paterno, to manage its Philippines business.

CIMB’s non-Malaysian operations already contributed 41% of the group’s profit before tax in 2012, up from 36% in 2011.

Malaysia’s RHB Banking Group, fresh from acquiring OSK Investment Bank, is bidding to build a foothold in the Singapore bond markets with a new team of capital markets bankers.

DMG & Partners Securities, the OSK-controlled Singapore brokerage, has appointed Kenneth Yeoh, a veteran of the Singapore bond market, as head of fixed income, responsible for helping develop the RHB-OSK group’s bond business outside Malaysia, with a focus on Singapore.

Things are looking positive.

Trade with China is two way, bringing benefits to the ASEAN region. HSBC group chief economist Stephen King believes the growth of this new “Southern Silk Road” is inevitable as China and the ASEAN leaders move up the global economic ladder – and will accelerate if the PRC succeeds in shifting its economy more towards domestic consumption.

Risks remain

The rosy picture, however, comes with a warning. Close ties to China mean that any wobble in the Middle Kingdom will affect South-East Asia.

Also, analysts are warning of “uncomfortably strong” credit growth across the region, a result of plentiful local bank liquidity and the explosion of Asia’s DCM in recent years.

HSBC’s Frederic Neumann is warning that the adoption of looser monetary policy in Japan could add to the risk of a debt bubble forming as the country’s megabanks look overseas for investments.

“Japanese banks have, historically, played an important role in transmitting the central bank’s financial impulse to the rest of the region. In the mid-1990s, for example, it was lending by Japan’s financial institutions, spurred by monetary easing and lack of investment opportunities in their home market, which added extra froth to Asia’s emerging debt bubble. It was also the sudden withdrawal of these institutions in the run-up to Japan’s recession in 1997 that starved Asia of desperately needed liquidity and hence contributed to the ultimate bust,” he said.

The Bank for International Settlements in December reported that international lending to Asia had continued to rise throughout the first half of 2012, despite rising risk aversion and many European lenders retreating.

While regional lenders’ expansions of their loan books explain much of that, low default rates are drawing international investors to South-East Asian debt.

Moody’s upgraded Indonesia to investment-grade status in 2012 and lifted its Philippines sovereign rating a notch to Ba1 – one rung below that of its neighbour. Analysts Steffen Dyck and Anushka Shah expect Asia’s sovereign credit profiles “will likely continue to improve relative to those in most other regions” in 2013.

More sovereigns are coming, too, increasing their US dollar exposure and paving the way for more corporate issuance. After Single B rated Mongolia made its long-awaited debut in the global debt markets in 2012 with a popular US$1.5bn bond, attention has shifted to other frontier markets.

Papua New Guinea, which is interested in joining ASEAN, has hired banks to advise it on its own sovereign debut. Myanmar is also attracting attention as it opens up to the global economy.

While international investors clamour for a piece of the next big bond issue, South-East Asia’s growing love of borrowing in US dollars is not without its risks.

Malaysia is bracing for a general election that analysts expect to be the closest since the country’s founding. Indonesia elects its president next year. Even Singapore is grappling with mounting public discontent.

Also, what happens when US rates eventually – and inevitably – start to rise? The hot money that is flowing into South-East Asia’s higher-yielding currencies could just as quickly reverse direction.

Rates markets believe Indonesia, Malaysia and Thailand are all more likely to raise rates in the next 12 months than they are to cut them – a sign of solid growth expectations, but also a warning that inflation may emerge, driving away fixed-income investments.

South-East Asia’s deeper local markets offer some protection, but ASEAN investors still prefer to invest in their own markets or in global instruments, rather than channel their investments towards supporting the region, according to S&P.

“ASEAN capital markets are among the fastest-growing around the world and are drawing increased attention from investors abroad, but more can be achieved to finance the region’s economic development and growth ambitions,” said Kathpalia.

There is, however, no cause for alarm just yet.

Investors in the US and Europe, are still struggling to generate returns in their own slow-growth economies, and analysts believe a wholesale capital flight out of Asia is unlikely in the near term.

“With global monetary conditions likely to remain benign and tail-risks in the West seemingly dissipating, the ‘great reversal’ of fund flows from emerging back to mature markets still seems some way off,” said HSBC’s Neumann.

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