Financial Integration and Bond Market Development in East Asia Masahiro Kawai Asian Development Bank OECD-ADBI 8th Round Table on Capital Market Reform in Asia 11-12 October 2006, Tokyo
Outline I. II. III. IV. V. VI.
Key Issues Financial Market Deepening in East Asia Financial Market Integration in East Asia Asian Bond Market Development Recent Policy Initiatives Challenges Ahead
I. Key Issues • One of the problems behind the Asian financial crisis of 1997-98 was Asia’s weak financial system. • Since the crisis, the East Asian economies have begun efforts to strengthen their financial systems and develop local-currency bond markets. • Asian financial markets have been deepening in terms of size, and regulatory and market infrastructure. • Asian financial market integration has been advancing but remains limited. • What is the current state of Asian Bond Markets Initiative (ABMI)? • What are the challenges ahead?
II. Financial Market Deepening in East Asia 1. International Benchmarking Analysis • Cross-country analysis of financial deepening—in the banking sector, equity markets and bond markets (for government bonds and corporate bonds)—vs. per capita GDP for 46 countries, including OECD and emerging market economies. • The regression analysis can indicate the extent of financial deepening that has taken place between 1995-1997 and 2002-2004, both for the world and for East Asia. • The analysis allows international comparison relative to the international benchmark or international norm.
Figure1-a. Financial MarketsDeepening (2002-2004Average)
Bonds + Equity + Bank Financing (% of GDP)
HK
600
US
Regressionresults: ?=154.39 + 6.87X t =( 6.09) (6.14)
Ř2=0.45
CH
500
NL JP
400
DK
MY PT ES SG
GR
300
LB CL TH CN BR
200 100
IS
IN PH
KR
BE SE FR IT DE FI AU CA UK AT
IE
NZ CZ
TR
PK CO AR ID RU PE
PLSK HU MX
-
5
10
15
20
25
30
GDPpercapita(USDthousands)
35
40
45
Figure 2-a. Banking Sector Deepening (2002-2004 Average)
Regression Results Ŷ = 75.17 + 2.27X t = (6.84) (4.66)
B a n k F in a n c in g ( % o f G D P )
300
Ř2 = 0.32 US
250 200
CH CN
LB
PT
MY
150
ES
BR
100
DE
HK
NZ
KR
TH
GR
CL
IT
50
IN ID
TR CO AR
PK
PL
RU
SK MX
UK AT
CA BE AU FR
SG PH
DK
NL JP SE
IS IE NO
FI
HU CZ
PE
-
5
10
15
20
25
30
GDP per capita (USD thousands)
35
40
45
50
Figure 3-a. Capital Markets Deepening (2002-2004 Average) Regression Results
500
Ŷ = 79.22 + 4.60X Ř2 = 0.43
450 B o n d s + E q u it y ( % o f G D P )
HK
t = (4.45) (5.85)
400 350 US NL
300 250
ZA
MY PT
GR
JP
BE
SG
200
IS
IT AU
ES
CA
SE
FI
FR
DK IE
DE
150
CL IN
100 50 PK
PH CN
UKAT
KR
BR TH TR
LB PL
ID CO RUAR PE
CZ HU
NZ
SK MX
-
5
10
15
20
25
GDP per capita (USD thousands)
30
35
40
Figure 5-a. Equity Market Deepening (2002-2004 Average)
E q u it y M a r k e t C a p it a lis a t io n ( % o f G D P )
450
Regression results HK
Ŷ = 46.03 + 1.43X Ř2 = 0.06
400
t = ( 2.85)
(2.00)
350 300 250 CH
200 150
SG
MY
AU CL
100 IN
50 -
TH BR CN PE RU PL TR PH ID CZ MX HU AR PK CO LB SK
-
5
10
PT KR
ES
FR
GR
IT
NZ
US
FI
CA
SE
BE DE
NL JP
IS DK
IE
NO
AT
UK
15
20
25
30
GDP per capita (USD thousands)
35
40
45
50
Figure 6-a. Bond Market Deepening (2002-2004 Average)
Regression Results Ŷ = 33.19 + 3.17X t = (3.63) ( 7.87)
B o n d s O u t s t a n d in g ( % o f G D P )
250
Ř2 = 0.58 NL IS
200
JP
US
DK
BE IT IE
150 GR
FR DE AT UK FI
PT ES
100
MY BR
50
PH TH
CZ
KR
SG HK
HU
AU NO
NZ
CL SK PK CN CO IN MX ID AR
-
SE
CA
LB
TR PL
CH
PE RU
-
5
10
15
20
25
30
GDP per capita (USD thousands)
35
40
45
50
Figure 8-a. Corporate Bond Market Deepening (2002-2004 Average)
Regression Results Ŷ = -1.32 + 2.64X t = (-0.17) ( 7.69)
C o r p o r a t e B o n d s O u t s t a n d in g ( % o f GDP)
200 175
IS
Ř2 = 0.56
NL
150
US DK
125
IE
100
CH UK FRDE
75
25 -
KR
MY
50
ES PT
SG
-
5
CZ HU
10
AT
SE JP
BE FI
CL
TH CN BRAR PL SK ID CO MX PK TR IN PH PE RU LB
HK
IT AU
NO
CA
NZ GR
15
20
25
30
GDP per capita (USD thousands)
35
40
45
50
Figure 9-a. Corporate Bond/Private Bank Financing Ratio & GDP (2002-2004 Average)
Regression Results Ŷ = 0.097 + 0.016X t = (1.85) ( 6.72)
C o rp o ate B o n d s / C o rp o rate B an k F in an cin g
1.25
Ř2 = 0.49 IS NL
1.00
IE DK
AR FR
0.75
IT
DE BE
FI AT UK
0.50
CZ
PE BR TH
SK MX PL ID CN IN CO TR LB PKPH RU
0.00 -
5
NO HK SG
PT
CL
CH
US
ES
MY
0.25
JP
AU KR
SE
HU
CA
NZ GR
10
15
20
25
30
GDP per capita (USD thousands)
35
40
45
50
II. Financial Market Deepening in East Asia 2. Major Findings • Over time, at the global level, financial deepening has taken place—upward shifts in the intercepts and slopes. • Emerging East Asia (EEA) is generally outperforming other parts of the world in the pace of financial deepening. • The strength of most East Asian economies are in the banking sector as well as in the equity market. • Bond market deepening is less impressive than its banking sectors and equity markets, with only Malaysia showing above-average performance. Nonetheless, bond markets— particularly corporate bond markets—have been deepening well over time relative to the international benchmark. • EEA’s financial sector is still unbalanced in favor of banks, but so are most economies.
II. Financial Market Deepening in East Asia 3. Policy Implications • Economies that are below the international benchmark in financial market deepening have to work harder to expand market size through appropriate policy measures—Philippines. • Economies that are above the international benchmark in financial market deepening have to work hard as well to improve the “quality” of the market—Malaysia and Korea. • There is still room for emerging East Asia’s bond market to deepen and develop.
III. Financial Market Integration in East Asia 1. Financial Integration • Financial integration has progressed in East Asia through financial market liberalization and opening, as well as through capital account liberalization, as part of the general trend of financial globalization • Despite the progress on market-driven financial development, the degree of financial integration remains low in East Asia • The degree of market opening and capital account liberalization varies across countries
III. Financial Market Integration in East Asia 2. Data Analysis • Cross-market differentials in interest rates and bond yields are declining • Cross-market co-movements in money and bond markets are increasing • Nonetheless, cross-market differentials in interest rates and bond yields are still significant • East Asian equity markets are more integrated than money or bond markets • Intra-regional cross-border portfolio investment is growing, but remains small relative to the region’s total cross-border portfolio flows
Cross-market differentials in interest rates and bond yields are declining Average Absolute Cross-Market Differentials 18
6
14
Interest rates
Bond yields
5
10
2-Year 4
3-Month
6
10-Year
Overnight 3
2 96
97
98
99
00
3 Month
01
02
03
Overnight
Source: Bloomberg LP and Datastream Note: Data for 2006 as of end-March
04
05
06
00
01
02
03
2-Yr
04
10-Yr
05
06
Cross-market co-movements in money and bond markets are increasing Average Absolute Distance of Beta Coefficients from Unity (in percentage points) 2.5
1.0
2.0
Interest rates
Bond yields
0.9
1.5
10-Year 0.8
3-Month
1.0
2-Year
Overnight 0.5 Dec97
0.7 Nov98
Oct99
Sep00
Aug01
3 Month
Jul02
Jun03
Overnight
Source: Bloomberg LP and Datastream
May04
Apr05
Mar06
Jan- Jun- Nov- Apr- Sep- Feb02 02 02 03 03 04
2-Yr
Jul04
Dec- May- Oct- Mar04 05 05 06
10-Yr
Correlation of stock returns among East Asian countries Sample period: January 2002 - March 2006 PRC PRC INO KOR MAL
1.00
INO
KOR
MAL
PHI
SIN
THA
JPN
HKG
USA
-0.05
0.11
0.29
-0.22
-0.09
0.01
0.07
0.25
0.04
1.00
0.33
0.31
0.52
0.39
0.31
0.31
0.26
0.28
1.00
0.39
0.33
0.57
0.39
0.54
0.57
0.67
1.00
0.15
0.62
0.30
0.19
0.55
0.37
1.00
0.45
0.44
0.26
0.04
0.20
1.00
0.44
0.24
0.51
0.63
1.00
0.33
0.40
0.43
1.00
0.41
0.39
1.00
0.66
PHI SIN THA JPN HKG USA
Source: Index values are from Bloomberg LP.
1.00
Investment, fixed-income capital, and equity markets (2004) Investment from:
Cross-Border Portfolio Flows inAsia USD Billion, 2004 NAFTA EU15 East Rest of the World Investment to: Total Portfolio Investment NAFTA 624 EU15 1,866 East Asia 588 Rest of the World 1,070 Total Global 4,149 Long-Term Debt Securities NAFTA 218 EU15 438 East Asia 62 Rest of the World 319 Total Global 1,037 Equity Securities NAFTA 389 EU15 1,253 East Asia 523 Rest of the World 718 Total Global 2,882
(15.0) (45.0) (14.2) (25.8) (100) (21.0) (42.2) (6.0) (30.8) (100) (13.5) (43.5) (18.1) (24.9) (100)
2,117 7,709 578 1,622 12,026
(17.6)
1,035 4,789 132 1,050 7,007
(14.8)
914 2,348 402 569 4,233
(21.6)
(64.1) (4.8) (13.5) (100)
(68.4) (1.9) (15.0) (100)
(55.5) (9.5) (13.4) (100)
849 944 149 688 2,630
(32.3)
615 718 49 492 1,875
(32.8)
212 179 78 164 632
(33.5)
(35.9) (5.7) (26.2) (100)
(38.3) (2.6) (26.2) (100)
1,877 1,733 182 650 4,443
(42.2)
1,297 1,036 64 368 2,765
(46.9)
237 415 48 267 967
(24.5)
(28.2) (12.3) (25.9) (100)
Source: International Monetary Fund, Coordinated Portfolio Investment Investment Survey, December 2004.
(39.0) (4.1) (14.6) (100)
(37.5) (2.3) (13.3) (100)
(42.9) (5.0) (27.6) (100)
Total Global 5,468 12,252 1,497 4,031 23,247
(23.5)
3,165 6,981 308 2,229 12,683
(25.0)
1,752 4,194 1,051 1,718 8,715
(20.1)
(52.7) (6.4) (17.3) (100)
(55.0) (2.4) (17.6) (100)
(48.1) (12.1) (19.7) (100)
III. Financial Market Integration in East Asia 3. Macroeconomic Interdependence • Macroeconomic interdependence is strong in East Asia as evidenced by synchronized economic cycles and high cross-country correlations of shocks • Japan; Korea; Taipei,China; and Hong Kong as well as middle-income ASEAN countries have a large degree of real macroeconomic co-movements, but China and low-income ASEAN countries do not • Surprisingly the United States (or EU, Australia, New Zealand, India) does not exhibit strong positive co-movements in real economic activity with East Asia, while co-movements in nominal variables are significant
Correlation Coefficients between the First Principal Component Scores for East Asia and Individual Economy Data (1980-2002)
Growth of Real Economic Activity
Price Inflation GDP Deflato r
CPI
WPI
-0.41
0.17
0.85
0.30
-0.18
-0.14
0.10
0.78
-0.01
-0.16
-0.15
-0.20
-0.02
0.31
0.00
New Zealand
0.27
-0.04
0.19
-0.07
0.40
0.22
India
0.09
0.01
-0.03
0.06
0.63
0.34
Japan
0.58
0.39
0.41
0.15
0.90
0.46
Korea
0.71
0.78
0.67
0.27
0.89
0.48
China, People's Republic of
0.07
-0.14
-0.26
-0.40
0.15
--
Taipei, China
0.51
0.28
0.28
0.35
0.85
0.50
Hong Kong, China
0.74
0.63
0.58
-0.06
0.80
--
Singapore
0.77
0.76
0.59
0.08
0.87
0.45
Malaysia
0.90
0.87
0.95
0.40
0.79
0.68
Thailand
0.89
0.92
0.88
0.54
0.87
0.70
Philippines
0.33
0.31
0.55
-0.06
0.57
0.27
Indonesia
0.89
0.65
0.89
0.99
0.21
0.92
Countries/Regions
GDP
Consumption
Investment
USA
0.01
-0.32
EU-15
0.01
Australia
IV. Bond Market Development 1. Progress on Bond Market Development • Total local currency bonds outstanding in emerging East Asia (EEA) more than tripled from $360 billion in 1997 to $1,650 billion in 2005, 48% of EEA GDP. • Despite growth, local-currency bond markets in EEA remain small, only 3% of total local currency bonds worldwide ($40 trillion). • The share of local currency bonds in EEA’s financial system is rising, from 13% in 1997 to 19% in 2004. • Market liquidity, measured by trading volume and turnover ratios, has risen in recent years, but remains low relative to OECD markets.
Emerging East Asia’s local currency bond markets have expanded in absolute size over the last 8 years, reaching $1,650 billion in 2005 from $360 billion in 1997. Size of Emerging East Asian Local Currency Bond Markets Market
1997 2004 2005 Amount Amount Amount ($ billion) ($ billion) ($ billion)
Annual Growth Rate (%) 1997 - 2003
2004
2005
PRC Indonesia Malaysia Philippines Singapore Korea Thailand Viet Nam
116.40 4.60 57.00 16.92 23.77 130.37 10.47 -
527.70 57.70 110.70 35.30 79.39 567.70 68.00 3.78
633.03 47.26 121.79 41.08 83.43 637.86 80.32 5.20
20.94 43.52 9.95 11.08 18.80 23.39 30.64
19.82 (12.18) 12.02 16.03 18.09 27.24 13.79 31.39
19.96 (18.09) 10.01 16.38 5.08 12.36 18.11 37.68
Total Emerging East Asia
359.53
1,450.27
1,649.97
22.05
19.72
13.77
Source: ADB Asian Bond Monitor, March 2006
Emerging East Asia’s bond market as a percentage of GDP continues to grow and has nudged to 48%, a significant increase from 16.5% in 1997 Size of Emerging East Asian Local Currency Bond Markets (% of GDP) Market
Amount Outstanding (% of GDP) 1997 2004 2005
PRC Indonesia Malaysia Philippines Singapore Korea Thailand Viet Nam
12.22 1.94 56.36 20.50 24.79 25.07 6.65 -
27.32 22.80 93.56 41.00 73.80 83.34 42.09 8.32
34.85 16.82 93.24 42.02 71.47 83.03 46.43 9.85
Total Emerging East Asia
16.54
42.85
48.02
Source: ADB Asian Bond Monitor, March 2006
Size and composition of East Asia local currency bond market has increased almost 5 folds. Evolution of Size and Composition of Emerging East Asian Local Currency Bond Markets, 1997-2005 (in billion US dollar) 1997 1998 1999 2000 2001 2002 2003 2004 2005 -
200
400
Source: ADB Asian Bond Monitor, March 2006
600
800
Government
1,000
1,200
Corporate
1,400
1,600
1,800
Local currency bond markets are increasingly becoming an important vehicle for channeling domestic savings to investment in emerging East Asia Bond financing now accounts for 19% of the total domestic financing, compared with 13% in 1997 75 67 60
60
45
30 20
15
19
21
13
0 1997 Bank Financing
2004 Bond Financing
Equity Financing
Proportion of foreign currency (FCY) bond issued in selected East Asian markets * had decreased about 12% since the 1997 financial crisis Average % of bonds issued in FCY Selected East Asian Countries (1997 - Jun 2005)
35 30
%
25 20 15 10 5 0 1997
1998
1999
2000
2001
2002
Ye ar (1997 - Jun 2005)
Source: http:asianbondsonline.adb.org
2003
2004
2005 (June only )
Turnover ratios are still low, particularly in corporate bond markets Corporate Bond Turnover Ratio
Government Bond Turnover Ratio PRC
Indonesia
Indonesia Korea
Korea Malaysia
Malaysia
Singapore Thailand
Thailand
Viet Nam -
0.5
1.0
1.5
2.0 2004
2.5
3.0
3.5
4.0
-
0.2
2005
Source: ADB Asian Bond Monitor, March 2006
0.4 2004
0.6 2005
0.8
With increasing short-term interest rates and relatively stable long rates, yield curves have flattened in all bond markets in emerging East Asia Yield Curve Slopes Market
(in basis points)
Jan-05
Mar-06
PRC Indonesia Korea Malaysia Philippines Singapore Thailand
2-yr vs 12-yr 2-yr vs 10-yr 3-yr vs 10-yr 3-yr vs 10-yr 2-yr vs 10-yr 2-yr vs 10-yr 2-yr vs 10-yr
230 190 62 172 250 130 210
93 54 42 48 106 56 23
Hong Kong, China Japan US
2-yr vs 10-yr 2-yr vs 10-yr 2-yr vs 10-yr
265 132 111
29 114 (3)
1. As slope approaches zero, the yield curve flattens . 2. Negative slope denotes inverted yield curve. Source: ADB Asian Bond Monitor, March 2006
IV. Bond Market Development 2. Issuers and Investors • Governments remain major issuers of local currency bonds in EEA, though corporations and financial institutions are becoming more active, particularly in Korea and Malaysia (where nongovernment entities are the largest issuers). • Bond holdings by commercial banks have been declining while holdings by contractual savings institutions (pension, etc) have been rising. • While the issuer base has expanded, overall investor base remains narrow and over half of local currency bonds are still held by commercial banks.
V. Recent Policy Initiatives 3. Major Initiatives • Executive’s Meeting of East Asia-Pacific Central Banks (EMEAP) to strengthen the demand side through ABF • ASEAN+3 Finance Ministers’ process to strengthen the supply side through the ABMI • APEC Finance Ministers’ process to work on overall financial sector development including bond markets • Asia Cooperation Dialogue (ACD) to raise political support to, and public awareness of, Asian bond market development in an expanded geographical coverage—28 countries, including ASEAN+3, South Asia, West Asia (Middle East), and Central Asia
Initiatives in Various Forums EMEAP
Use of Foreign Exchange Reserves
APEC
ASEAN + 3
Initiatives on Securitization & Credit Guarantees
Comprehensive initiatives with WG1, WG2, WG3, WG4, ASTFG
11 Central Banks ABF1 and ABF2
Action plans for Governments to be implemented
V. Recent Policy Initiatives 3-1. Asian Bond Market Initiative (ABMI) • WG1: Creating new securitized debt instruments • WG2: Credit guarantee and investment mechanisms • WG3: Foreign exchange transactions and settlement systems • WG4: Rating Systems • Ad-hoc Support Team for the Focal Group (ASTFG) now handling AsianBondsOnline, Asia Bond Monitor, and Asian Bond Standards • Technical Assistance Coordination Team in —now reporting to (ASTFG) * WG4: Issuance of bonds denominated in local currency by MDBs, government agencies and Asian multinational corporations—resolved due to success in 2005
V. Recent Policy Initiatives 3-2. Asian Bond Fund (ABF) • Initiated by EMEAP to strengthen the demand side • ABF-1 (June 2003, $1 billion) - Invest in sovereign and quasi-sovereign US dollar bonds issued by 8 members (excl. Japan, Australia, NZ)
• ABF-2 (December 2004, $2 billion) - Pan-Asian Bond Index Fund (PAIF), a single bond fund index investing in sovereign and quasi-sovereign local currency bonds issued by 8 members - Fund of Bond Funds (FoBF) with 8 country subfunds - Open to investment by the public - Local currency exchange-traded bond funds (ETF) listed in Hong Kong, Malaysia, and Singapore
ABF2 Framework Around USD1 billion
Around USD1 billion
EMEAP Group’s Investment in ABF2*
Fund of Bond Funds (FoBF) Parent Fund
Pan-Asian Bond Index Fund (PAIF)
8 Country Sub-Funds
CN
HK
ID
KR
MY
PH
SG
Underlying Bonds * The BIS will act as the Fund Administrator for EMEAP Group’s investment in ABF2. Components that will be open to investment by other public and private sectors. Source: EMEAP.
TH
Issuance of local-currency denominated bonds by supra-nationals and foreign (public or quasipublic) entities in ASEAN+3 countries Date
Country
Issuer
Amount
Tenor
Nov 04
Malaysia
ADB
MYR400 million 5-year bond
Dec 04
Malaysia
IFC
MYR500 million 3-year Islamic bond
May 05
Malaysia
WB
MYR760 million 5-year Islamic bond
May 05
Thailand
ADB
THB 4 billion
5-year bond
Sep 05
Thailand
JBIC
THB 3 billion
5-year bond
Oct 05
PRC
ADB
CNY 1 billion
10-year Panda bond
Oct 05
PRC
IFC
CNY1.13 billion 10-year Panda bond
Oct 05
Philippines
ADB
PHP 2.5 billion
Apr 06
Malaysia
ADB
MYR500 million 5 year bond*
May 06
Malaysia
KfW**
MYR500 million 7-year bond
5-year bond
VI. Challenges Ahead 1. Building a Well-functioning Bond Market • Financial sector reforms—including further development of local currency-denominated bond markets—is key to Asia’s financial sector development and integration • Asian bond market development helps allocate financial resources more efficiently through price discovery and better risk management • Corporate governance—Strong corporate governance is a must so that borrowers and corporations are subject to sufficient checks and balances
VI. Challenges Ahead 2. Immediate Challenges in Bond Markets • Deepen bond market liquidity—through greater price transparency such as better price guidance for (illiquid) assets and more immediate transaction disclosure • Increase timely information about issuers—through improvement of the quality of credit rating agencies and their frequent reporting, and requiring issuers to increase reporting frequency • Expand investor base and diversity—through more equal treatment regarding transaction-related requirements and taxation
VI. Challenges Ahead 3. Regional Cooperation • Regional cooperation—through ASEAN+3 and EMEAP—is a powerful tool to achieve joint improvements of bond markets, financial integration and financial stability • Regional efforts toward: credit enhancement; regional settlement system; regional rating agency; and regional common standards based on best practices
Thank you Dr. Masahiro Kawai Special Advisor to the President & Head, Office of Regional Economic Integration Asian Development Bank
[email protected] +63-2-632-6688 http://asianbondsonline.adb.org www.adb.org