Integrating Asian finances

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Integrating Asian finances

• Robert N McCauleyChief Representative
• BIS Asian OfficeBank for International
  Settlements
• World Bank / Hong Kong Monetary Authority
  Conference East Asian Financial Marketsthe Next
  Frontier
• Hong Kong, 22-23 June, 2006

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Main points

• Financial integration in Asia varies across
  markets
• In bond market, risk is that regional integration
  takes place in offshore US dollar market,
  encouraging currency mismatches
• Policy priority develop local currency bond
  market, especially corporate bond market
• Open local currency bond market to foreign
  investment to allow regional integration there?

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Integration of Asian financial markets
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Integration of bank credit marketsForeign bank
share of domestic credit in percent
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BIS-reporting banks claims on China
IndiaEnd-September 2005, in US billions
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Very limited role of foreign investors in local
currency bond markets

• Typical holdings of 1-3, although effectively
  higher in markets like Korea where can invest in
  government bond futures and interest rate swaps.
• Highest ratio of over 10 currently for
  high-yielding Indonesia.
• China, India limit by restrictions, others by
  withholding taxes.
• Closed markets, idiosyncratic price changes

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Return correlations btw Asian local currency
bonds (ex HK, SG) and US Treasury bonds low
Calculated over period January 2001 to March 2004.
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Dollar bond and syndicated loan markets show
regional integration

• 40 of dollar bonds sold by Asian issuers bought
  by Asian accounts
• Similar fractions of syndicated loans for Asian
  borrowers taken up by banks from Asia

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(No Transcript)
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Stock markets (ex China) moderately integrated
Calculated over period January 2001 to March 2004.
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Risk is that regional integration of bond markets
happens in US dollar market

• This could entail risk of currency mismatches if
  firms borrow dollars to access global portfolios
  and to obtain longer maturities.
• If best firms access offshore rather than onshore
  funding, local currency corporate bond market
  left without its most liquid issues.
• Lower quality firms may be pushed offshore by
  credit risk aversion of domestic investors.

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Policy imperative is to build up national bond
markets in local currency

• Against threat of global markets
  cherry-picking, regional efforts to build up
  domestic bond markets
• ABF2 can be seen as a case of collective learning
  by doing that has prodded removal of impediments
  as well as providing domestic investors a cost
  effective means to invest in local bonds.
• Also made crossborder investment easier through
  the Pan Asia fund.
• Sale of local currency bonds by international
  financial institutions has helped to increase the
  diversity of credit on offer in bond markets of
  China, Malaysia and Thailand.

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Costs and benefits of allowing foreign investment
in local bond markets

• Costs
• As in equity markets, foreign investors can chase
  returns, possibly amplify price swings and rush
  for exit
• Higher correlation with US Treasury market?
• Benefits
• Firms have choice other than to sell dollar bonds
  to tap offshore funds
• Greater diversity in investor base tends to
  improve liquidity
• Foreign investors stabilising bid when domestic
  liquidity shocks?

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Net equity flows into Asia in billions of US
dollars
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Conclusions

• The key choice is what kind of fixed income
  market integration Asia wants one based on the
  dollar markets or one based on domestic
  currencies.
• Policy-makers need to do what is necessary to
  ensure that their domestic bond markets,
  especially corporate bond markets, can support
  growth.
• Foreign investors in domestic bond markets could
  provide a more diverse investor base but could
  expose the local markets to global bond market
  strains and possibly large inflows and outlows.

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