Asia Is Finding Ways to Cope With Tapering

Asia Is Finding Ways to Cope With Tapering

Old financing models were growing less viable anyway. Fortunately change is afoot.

DAVID MORTON

Feb. 26, 2014 11:28 a.m. ET

The past seven months have seen several moments of market turmoil in Asia, with investors worrying about the potential for destabilizing capital flight out of the region as central bankers in the U.S. wind down quantitative easing and interest rates start returning to normal. While monetary tapering will have an effect on Asia, that effect has been exaggerated—not least because the region’s financial markets are evolving in ways that make them far more resilient in the face of developments elsewhere.

When it comes to the relationship between the U.S. Federal Reserve and Asia, it helps first to understand the numbers. A recent World Bank paper estimates that only around 13% of gross inflows into global emerging markets between 2009 and the beginning of 2013 were specifically linked to quantitative easing. The paper forecasts that the unwinding of QE will cut capital inflows by only 0.6% 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 then in the expectation that Basel III banking regulations will require higher capital reserves. Although the phenomenon is real, the region’s own financial institutions seem to have more than enough cash to make up for the shortfall.

It is also 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.

But last June’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 with Basel III on the horizon are looking for ways to deliver capital to their clients that do not put extra pressure on their balance sheets. Asia will need to find capital somewhere: We estimate that Asia needs to invest some $11.5 trillion in public-works projects alone between 2010 and 2030 to accommodate another 650 million people moving to cities.

These facts are stimulating further developments in the structure of Asian capital markets. Despite the continent’s voracious appetite for capital as it transformed itself over the past 30 years, the plain vanilla bank loan has reigned supreme, leaving much of the region with a residue of lopsided equities offerings, stunted capital markets and an alternative-investments environment that has failed to mature beyond infancy.

This system for supplying capital is no longer sufficient. 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.

Asian businesses of necessity are becoming more sophisticated about how they obtain capital. As they confront rising wages, growing competition and falling export demand in the West, they are exploring more efficient methods for raising capital. 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 result of all these converging influences is that the Asian funding environment is starting to become more flexible, more customer-oriented and more efficient. One sign of this is the growing interest among Asian companies in stock listings. We expect listings to pick up substantially this year.

We have seen noticeably more interest from industries such as retail, real-estate investment trusts and property developers in raising funds in the equities market. The slow pace of listings in the past couple of years has left a legacy of pent-up demand, which is being reflected in significantly more inquiries in recent months from clients who are optimistic that a return to steady growth is more likely.

Asian companies are also broadening their sources of debt financing. We expect more firms to opt for high-yield bond issues and structured debt, or term loans from non-bank sources including institutional investors, private equity, hedge funds and sovereign wealth funds. The evidence of this shift is already clear: Syndicated lending to Asia ex-Japan hit $462 billion last year, an increase of 51% over 2012.To date the limiting factor on this kind of borrowing has been a shortage of international banks with the expertise to intermediate between the many companies interested in exploring this option and the many possible sources of such financing.

It’s easy to blame all of Asia’s capital woes on Fed tapering. But that misses both the ways in which the funding situation was bound to become more complicated anyway—as the old system became less and less suitable to Asia’s developing economies—and the ways in which the market already is rising to the challenge.