Asia’s funding markets are stirring and all the indications are that the continent is on the cusp of an unprecedented period of financial innovation that will provide the fuel for its next period of expansion.
Despite the continent’s voracious appetite for capital as it has transformed itself over the past 30 years, the plain vanilla bank loan has reigned supreme, stifling the growth of other capital raising options such as the region’s equities and capital markets and alternative investments environment.
Asia is fast outgrowing the bank loan model as its principal source of finance and the change is secular rather than cyclical. In relative terms, the first phase of industrialization that propelled the region into prosperity was cheap.
The next phase, where growth is powered by a combination of productivity gains and moving up the value chain, will be much harder to achieve and much more expensive. Even in the absence of other non-secular changes in the global financial environment, the bank loan model would have been unable to support continuing growth on its own.
The structure of Asia’s capital supply is changing.
We believe the down-scaling of the US Federal Reserve’s quantitative easing program is and will continue to have a profound effect on financing in the region, but not in the way that most people suppose.
The fears that the taper will spark a massive withdrawal of funds from emerging markets and subsequent capital drought are exaggerated.
A recent World Bank paper estimates that just 12.8 percent of gross inflows into emerging markets between 2009 and the beginning of last year were specifically linked to Quantitative Easing (QE). The paper forecasts that the unwinding of QE will cut capital inflows by just 0.6 percent of emerging market GDP by 2016.
Similarly, we see little evidence of a capital drought as Western banks cut their loan books in Asia, first in response to the financial crisis and latterly in the expectation that Basel III banking regulations will require higher capital requirements.
Although the phenomenon is real, the region’s own financial institutions seem to have more than enough cash to make up for any shortfall.
It also looks probable that even with the taper, Western central banks will seek to keep interest rates low for the foreseeable future, encouraging investors to continue to look to emerging markets in their search for yield.
Although growth in emerging markets is unlikely to return to the heady levels it experienced before the crisis, we still expect developing economies globally to grow almost three times faster than developed economies this year.
However, June last year’s “taper tantrum” and the reduction in western bank loans have nonetheless focused the attention of Asian businesses on the potential vulnerability of their financing model; and banks — looking forward to Basel III — are looking to deliver capital to their clients in ways that do not put extra pressure on their balance sheets.
The demand profile for funding is also changing. Asian businesses are becoming increasingly sophisticated as they seek to optimize fiscal efficiency in the face of rising wages, growing competition and falling demand in the wake of the financial crisis.
Adding to the demand-side pressure for change are deregulation in China and fears of a maturity mismatch, particularly on long-term infrastructure financing. We estimate that Asia needs to invest about US$11.5 trillion in infrastructure alone between 2010 and 2030 to accommodate another 650 million people moving to cities.