Asia’s financial catch-up

Pim Korsten
March 23, 2018

Asia’s financial catch-up

Pim Korsten
March 23, 2018

Asia’s financial catch-up

Pim Korsten
March 23, 2018
Asia’s financial catch-up
Pim Korsten
Maya Turolla
March 23, 2018
Photograph: Beijing's financial district

Although Asia has become the biggest economic region in the global economy in recent years, its financial sector is lagging behind. However, increased momentum in hegemonic, technological and economic developments will accelerate Asia’s rise as a financial powerhouse. As a result, Asia will increasingly become a major player in the global financial system trailing its economic rise.

Our observations

  • McKinsey estimates that capital market development in emerging Asia could free almost $800 billion in funding annually, spurring economic growth by financing infrastructure gaps, boosting financial inclusion for poor households and reducing the cost of funding for SMEs.
  • Recently, the People’s Bank of China announced new measures to encourage cross-border yuan transactions, aiming to “create an excellent business environment, and service the Belt and Road Initiative.”
  • We have written before how last year’s demonetization in India can be considered a move to build India’s digital financial system, which is on its turn boosting financial inclusion and India´s digital economy. Other major economies in Asia, like Indonesia and Vietnam, also have significant opportunities for stimulating their digital economies and fintech.
  • Yi Gang will be the new head of the People’s Bank of China, and has a reputation of being pro-reform. "The main task right now is to implement prudent monetary policy, push forward financial sector reform and opening up, and keep the financial sector stable," Yi told reporters in his first interview. At the end of last year, China vowed to open its finance sector to foreign investors, a historical move.
  • China has established “Stock Connect” links between Shanghai, Shenzhen and Hong Kong to create a single Chinese stock market that is to be one of the biggest in the world. Northbound and southbound trading volumes in the Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect in both directions grew by 194% and 170% respectively in 2017.
  • Singapore, Hong Kong, Tokyo and Shanghai are currently the world’s most competitive financial centers, after London and New York. When asked which financial centers will significantly gain in relevance in the coming years, nine Asian hubs feature in the top 15.

Connecting the dots

Asia is currently the fastest growing and has become the largest economic region in the global economy in recent decades. However, Asia’s financial development still lags behind its economic rise. First of all, Asia’s internal financial market is one of the least financially integrated markets, as currently more capital flows between Asia and other regions than within Asia. Furthermore, Asia’s long-term savings markets and institutional savings vehicles – like pension, insurance and mutual funds – are underdeveloped, although growing very rapidly in recent years (Asia’s sovereign wealth fund sector is relatively large, as we have written before). Lastly, Asian equity and bond markets are still immature, generally lacking liquidity, depth and trading volume compared to major stock exchanges in developed markets, with strict regulation for offshore funding.There are three axes along which momentum is building for Asia’s financial development. The first is that large investment projects are currently undertaken that deepen regional trade and FDI– like China’s BRI, the Japanese-Indian Asian-African Growth Corridor or India’s maritime investment policy. Financial integration generally follows the tracks of trade and FDI and considering these projects also explicitly promote financial integration - like better access to offshore bond and FX markets - it is expected that intra-Asian financial integration accelerate along with these projects.Second, the digitization in many Asian societies and economies is gaining momentum. The adoption of digital technology, such as smartphones with internet connections, can stimulate financial inclusion, by giving lower- and middle-income households and SMEs better access to traditional finance mechanism from which they were previously excluded (i.e. commercial banks) or new funding sources (i.e. P2P lending or micro-credits). For example, poor Indians now ‘pay’ with their data instead of collateral when taking on loans, and the rise of China’s fintech and e-commerce industry shows how local Chinese companies benefit from global business opportunities in the digital economy. Lastly, Asian powerhouses want to leverage their economic rise into a more dominant position in the global financial system, for example by establishing financial hubs, as we have written before. There are economic reasons, like benefitting from increased household wealth and supply of savings in the world’s fastest growing economic region, but also hegemonic motives, especially as competition and rivalry between regional Asian economies intensify. Japan, for example, as it is ending its decade-long deflation, wants to boost Tokyo as leading financial hub for intra-Asian trade amid political turbulence in London (Brexit), New York (Trump’s presidency and trade wars), Hong Kong (Chinese ‘mainlandization’) and Shanghai (financial regulations in recent years). And Asian economies want to boost their own currency in the global financial system or divert their dependency on the U.S. Dollar. China’s Renminbi, for example, accounted for less than 2% of global transactions last year, while China accounts for 15.5% of global GDP (18.8% in PPP terms). The same goes for the Indian rupee, which accounts for barely 1% of global transactions, while India’s economy accounts for 3.2% of global GDP (7.7% in PPP terms).

Implications

  • More mature and developed capital and FX markets in Asia can increase stickiness of foreign ownership, thereby reducing market volatility and making large financial dislocations like the Asian financial crisis less likely. This will be a further boon for financial market liberalization and foreign ownership of Asian assets pushing their P/E ratios.
  • However, with large financial reforms come large responsibilities, and the recent build-up of debt, especially in China, is just one example of the difficulties Asia’s financial rise will face. Instability in Asia’s financial markets might become a serious theme in the medium-term.
  • Increased financial inclusion will boost productivity for the poor and middle-income consumers, reduce their precautionary savings, hence boost disposable income for Asian consumers.
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