going regional: how to deepen asean's financial markets

7/27/2019 Going Regional: How to Deepen ASEAN's Financial Markets

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Going Regional: How to DeepenASEANs Financial Markets

Maria Socorro Gochoco-Bautista and Eli M. Remolona

No. 300 | January 2012

ADB EconomicsWorking Paper Series


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ADB Economics Working Paper Series No. 300

Going Regional: How to DeepenASEANs Financial Markets

Maria Socorro Gochoco-Bautista and Eli M. Remolona

January 2012

Maria ocorro ochoco-Bautista is enior conomic Advisor conomics and esearch epartment Asian'HYHORSPHQW%DQNDQG(OL05HPRORQDLV&KLHI5HSUHVHQWDWLYH$VLDDQG3DFLF2IFH%DQNIRU,QWHUQDWLRQDO6HWWOHPHQWV7KHYLHZVH[SUHVVHGKHUHLQGRQRWUHSUHVHQWWKHYLHZVRIHLWKHUWKH$'%RU%,67KHDXWKRUVthank oli . otocinal for excellent research assistance. The authors accept responsibility for any errors in

the paper.


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Asian evelopment Bank AB Avenue Mandaluyong City Metro Manila hilippineswww.adb.org/economics

by Asian evelopment Bankanuary ,661ublication tock o. 44

The views expressed in this paperare those of the authors) and do notQHFHVVDULO\UHHFWWKHYLHZVRUSROLFLHVof the Asian evelopment Bank.

The AB conomics orking aper eries is a forum for stimulating discussion and

eliciting feedback on ongoing and recently completed research and policy studies

undertaken by the Asian evelopment Bank AB) staff consultants or resource

persons. The series deals with key economic and development problems particularly

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methodological issues relating to project/program economic analysis and statistical data

and measurement. The series aims to enhance the knowledge on Asias development

and policy challenges; strengthen analytical rigor and quality of ABs country partnership

strategies and its subregional and country operations; and improve the quality and

availability of statistical data and development indicators for monitoring development

effectiveness.

The AB conomics orking aper eries is a quick-disseminating informal publication

whose titles could subsequently be revised for publication as articles in professional

journals or chapters in books. The series is maintained by the conomics and esearch

epartment.


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Contents

Abstract v

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C. Market Making in the merging AA Bond Markets 4

. hy ize Matters for eep and iquid Markets

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eferences 4


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ABSTRACT

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banking systems are already reasonably well-developed while stock markets

and government bond markets have evidently achieved critical mass

even while remaining purely domestic markets. The tug-of-war between

the geography of information in the direction of more localized markets

versus the critical mass required by network externalities makes the casefor regional integration stronger for corporate bond markets than for other

QDQFLDOPDUNHWV7KHVWXG\SURSRVHVWKUHHEROGLQLWLDWLYHVWRGHYHORSD

deep and liquid regional corporate bond market.


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I. INTRODUCTION

Countries in the Association of outheast Asian ations AA) aspire to belong to a

region of high and inclusive growth and high productivity one tied together by bonds of

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crisis AA countries strengthened their banking systems improved regulatory oversight

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recovery from this crisis was quicker and more robust than that in other regions.

et it also cannot be denied that the underdevelopment of the regions capital markets

ZDVDQRWKHUUHDVRQIRUWKHUHVLOLHQFHRIWKHQDQFLDOVHFWRU7KLVXQGHUGHYHORSPHQWPHDQW

that exposures in the region to the subprime mortgages and other toxic assets in the nited

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crisis had led to high savings and the build-up of foreign exchange reserves which served

to protect the region during the more recent global crisis.

But the cost of such protection along with the underdevelopment of capital markets

has been high. This cost has manifested itself in persistently low investment in the region.

ow investment in turn has adverse implications on the regions ability to foster inclusive

growth primarily through employment generation that normally comes with investment. Theunderdevelopment of capital markets and the dependence on banks as a primary source of

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region has been sending its savings abroad to be intermediated by the capital markets of

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low-yielding reserve assets while the markets abroad turned the savings into risky higher-

return investments. ome of these investments found their way back into the region while

some of them ended up in toxic assets outside the region.

7KH$6($1FRXQWULHVIDFHWZRGLIIHUHQWFKDOOHQJHVRU&DPERGLDWKHDR3HRSOHV

'HPRFUDWLF5HSXEOLFDR3'50\DQPDUDQG9LHW1DPWKHFKDOOHQJHLVWRIXUWKHUGHYHORS

WKHLULQVWLWXWLRQVDQGEDQNLQJV\VWHPVRU,QGRQHVLD0DOD\VLDWKH3KLOLSSLQHV6LQJDSRUHand Thailand it is to further deepen their capital markets without unduly exposing these

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1 Nijathaworn (2011) points out that one lesson o the 1997 Asian crisis was the importance o sel-insurance in theorm o stockpiling oreign exchange reserves.


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has made great strides in this regard. Their equity markets and government bond markets

already exhibit remarkable depth and liquidity. This would seem to imply a two-speed track

of market development with some countries individually making their banking systems their

UVWSULRULW\ZKLOHWKHRWKHUVFRQWLQXHWRGHHSHQWKHLUFDSLWDOPDUNHWV,QWLPHWKHUVWJURXScan try to catch up by emulating the more developed ones. But for the second group their

task is not so straightforward. The market that has remained conspicuously shallow and

illiquid throughout the region is the corporate bond market. To develop this market doing

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in AA that do have banking systems have come to rely excessively on their banks. They

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WRDKDOWWKHGRPHVWLFFRUSRUDWHERQGPDUNHWVVWHSSHGLQWRSURYLGHQDQFLQJWRDIHZof the larger AA companies albeit in a very limited way. A deeper market would have

welcomed many more companies that were starved for funds including ones that never did

have access to the international credit markets.

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fundamental advantage in processing the necessary information for investment decisions.

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PRELOLW\7KHWDLOULVNVRIXQKLQGHUHGFURVVERUGHURZVLQYROYHVXGGHQVWRSVDQGFXUUHQW

DFFRXQWUHYHUVDOVDVZHOODVWKHLUWHQGHQF\WRQDQFHDVVHWSULFHEXEEOHVWKDWHYHQWXDOO\lead to disruptive and costly adjustments. These costs are especially high in economies

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markets need to develop further. These are the markets that would make the most difference

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iven the prerequisites of liquidity and the scale economies that the development of bond

markets entail regional cooperation and coordination should provide the local network

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regional cooperation which would facilitate the growth and development of corporate bondmarkets in the AA.

II. THE RECYCLING OF SAVINGS

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that there was a general increase in savings rates in Asia. Much of the growth in savings

in Asia is attributable to the eoples epublic of China C) which together with apan

accounts for the bulk of savings in the region. The Cs average savings rate increased

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shows the evolution of savings and investment ratios in the AA the AA togetherwith the C apan and the epublic of orea as well in advanced economies. AA

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contrast the savingsinvestment gaps in advanced economies was consistently negative

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Going Regional: How to Deepen ASEANs Financial Markets | 3


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Figure 1: Savings and Investment (% o GDP)

10

15

20

25

30

35

40

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

ASEAN SavingsASEAN+3 SavingsAdvanced Economies Savings

ASEAN InvestmentASEAN+3 InvestmentAdvanced Economies Investment

ASEAN = Association o Southeast Asian Nations, GDP = gross domestic product.Note: ASEAN includes Brunei Darussalam, Cambodia, Indonesia, the Lao PDR, Malaysia, Myanmar, the Philippines, Singapore, Thailand,

and Viet Nam; ASEAN+3 includes the PRC, Japan, and the Republic o Korea.Source: Sta calculations using data rom the World Economic Outlook(IMF 2011b) and the World Development Indicators (World Bank

2011).

merging Asias average investment rates did not grow as fast as its marginal

propensity to save. The average rate of investment as a percentage of increased by

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$VLDQQDQFLDOFULVLV9DULRXVSRVVLEOHH[SODQDWLRQVKDYHEHHQDGYDQFHG6RPHKDYHFLWHGthe lack of animal spirits after accounting for other possible factors; risk aversion increased

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explanation that has been neglected in the literature is simply that the cost of investment has

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lobal investors now demand rather high rates of return for investments in Asia.

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4 | ADB Economics Working Paper Series No. 300


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Table 1: Savings and Investments as a Percentage o GDP

Savings Rates Investment Rates Surplus Savings

19901997 20002007 19901997 20002007 19901997 20002007

Indonesia 32.3 26.7 39.2 23.9 7.0 2.8Malaysia 33.2 35.0 39.3 23.0 6.1 12.1Philippines 18.8 18.0 23.1 17.0 4.2 1.0Singapore 46.9 41.7 34.6 23.0 12.4 18.7Thailand 34.1 29.1 40.2 26.1 6.2 3.0Brunei Darussalam 37.9 49.9 29.3 14.0 8.6 35.9Cambodia 10.4 16.7 12.1 19.0 1.7 2.4Lao PDR n.a. 19.2 n.a. 30.7 n.a. 11.5Myanmar 10.7 16.2 13.9 12.4 3.3 3.9Viet Nam 18.4 33.1 19.4 35.1 1.0 2.0

GDP = gross domestic product.Source: IMF International Financial Statistics, available: (http://elibrary-data.im.org), downloaded 14 September 2011.

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crisis. ence the C and most of the economies in the AA accumulated surplus

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WKHQXPEHUVRQWKHVXUSOXVVLGHZKLOHWKH86GRPLQDWHVRQWKHGHFLWVLGH

Figure 2: Current Account Balances ($ million)

1,000,000800,000

600,000

400,000

200,000

200,000

0

400,000

600,000

800,000

EuropeIndiaJapanASEAN

United StatesRepublic o KoreaPeoples Republic o China

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

ASEAN = Association o Southeast Asian Nations.Note: ASEAN includes Brunei Darussalam, Cambodia, Indonesia, the Lao PDR, Malaysia, Myanmar, the Philippines, Singapore, Thailand,

and Viet Nam.Source: IMF International Financial Statistics, available: (http://elibrary-data.im.org), downloaded 14 September 2011.



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Bernanke ) attributes the trend in global current account imbalances to the

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of the imbalance. Cheung and ustecilli ) extend the analysis of current accountimbalances by dichotomizing the various factors as either structural or cyclical and conclude

that structural factors generally drive the persistence of the imbalance. ruber and amin

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of the current account which effectively imply some form of heightened risk aversion and

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the current account controlling for institutional factors the legal environment and degree of

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outcomes in industrialized countries. They argue that the scarcity of savings in the

underinvestment in Asia presumably due to increased risk aversion and the well-developed

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The regions surplus savings were channeled to bank deposits given an increase in

ULVNDYHUVLRQDIWHUWKH$VLDQQDQFLDOFULVLV7KLVJDYHEDQNVDVXEVWDQWLDOVRXUFHRIGHSRVLWV

that it could tap as the regions largely export-led growth led to an increase in the demand

for credit. xport-led growth and the surplus savings in the region translated to persistent

current account surpluses beginning at the turn of the century. The corresponding net capital

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The increase in Asian surplus savings the sterilized interventions by the Asian monetary

authorities and the institution of micro-prudential regulation through strict imposition of Basel

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Mohanty and Turner ). The availability of local currency government bonds also gaveVRPHHOERZURRPIRUOLXLGLQYHVWPHQWVZLWKUHODWLYHO\KLJKUHWXUQVDQGDPSOHOLXLGLW\,Q

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on wholesale fund providers typically of short-term capital in lieu of retail deposits. The

reduced reliance on retail deposits did not occur in developing Asia where bank deposits as

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2 These are cross-country dierences in demographics, fscal defcits, oil dependency and intensity, stage o economicdevelopment, fnancial market development, and quality o institutions.



14/52

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the poorer countries to the rich countries. tudies such as im im and ark ) showWKDWDOWKRXJKLQYHVWPHQWLQHPHUJLQJ$VLDLVXOWLPDWHO\QDQFHGE\VDYLQJVLQWKHUHJLRQ

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the form of low-yielding reserve assets and come back largely in the form of foreign direct

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FHQWHUVOLNH1HZ


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intermediation of surplus savings and its eventual reinvestment into the region could contributeWRQDQFLDOYXOQHUDELOLW\LIFDSLWDOLQRZVLQWR$VLDDUHODUJHYRODWLOHDQGZLWKD KLJKULVN

of sudden stops or reversal. There are risks associated with full or a high-level of capital

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III. THE DOWNSIDE OF CAPITAL MOBILITY

The rationale for capital account liberalization and full mobility of capital rests on the

neoclassical assumptions of complete and well-functioning markets bereft of information

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ULVNUHGXFWLRQDQGFRQVXPSWLRQVPRRWKLQJSURYLGHGQDQFLDOPDUNHWVDUHVXIFLHQWO\GHHSWRbe characterized as complete Cochrane ). The assumptions of market completeness

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WKHSROLF\SUHVFULSWLRQRIFDSLWDOOLEHUDOL]DWLRQDQGQDQFLDOLQWHJUDWLRQ

,QWHUQDWLRQDOFDSLWDOPRELOLW\LVQRWXQDPELJXRXVO\ZHOIDUHLPSURYLQJEHFDXVHWKH

UHDOZRUOGLVQHLWKHUSHUIHFWQRUIUHHIURPGLVWRUWLRQV(LFKHQJUHHQDQG3DUN&RRSHU

7KHLQKHUHQWLQWHUWHPSRUDOQDWXUHRIWUDGHLQQDQFLDODVVHWVPDNHVLWIXQGDPHQWDOO\

different from trade in goods. ote that the promised payment of the borrower is contingent

RQVRPHIXWXUHVWDWH,QIRUPDWLRQDV\PPHWU\RQWKHVLGHRIWUDQVDFWLQJSDUWLHVLQWURGXFHV

PRUDOKD]DUGDQGDGYHUVHVHOHFWLRQSUREOHPVRQERWKVLGHV7KLVLVH[HPSOLHGE\WKH

irrational lending behavior of mortgage originators in the run-up to the mortgage crisis of6WLJOLW]7KHVHGLVWRUWLRQVUHSOLFDWHGDQGDJJUHJDWHGWRWKHPDFUROHYHOFRXOG

OHDGWREXEEOHVSDQLFVDQGPDQLDVLQQDQFLDODVVHWWUDGLQJDFWLYLW\WKDWVRPHWLPHVOHDG

to full blown crises especially if agents involved are systemically important entities.

'LVWRUWLRQVRQWKHUHDOVLGHRIWKHHFRQRP\DOVRPDWWHU&URVVERUGHUFDSLWDOLQRZV

to domestic industries with little comparative advantage are welfare-reducing in the long run.

&DSLWDOPD\RZWRDORZWD[FRXQWU\UHJDUGOHVVRIWKHSURGXFWLYLW\RIFDSLWDOWKHUHGULYHQ

VROHO\E\GLIIHUHQFHVLQPDUJLQDOWD[UDWHVDFURVVFRXQWULHV7KLVLVOLNHZLVHLQHIFLHQWDQG

DULVHVRXWRIDSULRULH[LVWLQJGLVWRUWLRQVEURXJKWDERXWE\GLIIHUHQFHVLQVFDOSROLF\

:LWKWKHSRVVLEOHH[FHSWLRQRI6LQJDSRUHWKHUHODWLYHXQGHUGHYHORSPHQWRIQDQFLDO

systems in AA is argued not only to have limited potential gains from capital accountOLEHUDOL]DWLRQEXWDOVRWRKDYHFRQWULEXWHGWRWKHYXOQHUDELOLW\RIWKHUHJLRQWRQDQFLDOVKRFNV

7KHGLIFXOW\LQHIFLHQWO\LQWHUPHGLDWLQJ$6($1VDYLQJVZLWKLQWKHUHJLRQKDVHQFRXUDJHG

VKRUWWHUPFURVVERUGHUEDQNDQGSRUWIROLRRZV7KHKLJKJURZWKHQYLURQPHQWIURP

WRDQGWKHODFNRIZHOOGHYHORSHGORFDOFRUSRUDWHERQGPDUNHWVPHDQWWKDWODUJH$VLDQ



16/52

borrowers turned largely to domestic banks which in turn borrowed heavily overseas in

foreign currencies with short maturities. This double mismatch in exposures rendered the

EDQNLQJV\VWHPH[WUHPHO\YXOQHUDEOHWRFDSLWDORZUHYHUVDOV

7KHUHLVHYLGHQFHWKDWWKH$VLDQQDQFLDOFULVLVLQFKDUDFWHUL]HGE\FRQWDJLRQ

DQGFDSLWDORZUHYHUVDOVKDGLWVPRVWVHYHUHLPSDFWRQHFRQRPLHVZLWKXQGHUGHYHORSHG

QDQFLDOV\VWHPVHOPDQHWDODUJXHWKDWWKHEDQNFHQWULFFKDUDFWHULVWLFRIWKH

$6($1QDQFLDOV\VWHPV LQWKHUXQXSWRFRXSOHGZLWKDUHODWLYHO\KLJKGHSHQGHQFH

RQYRODWLOHFDSLWDOLQRZVODUJHO\FRQWULEXWHGWRFULVLV&DSLWDORZUHYHUVDOVLQWKHFRQWH[W

RIXQGHUGHYHORSHGQDQFLDOPDUNHWVPDGHWKHUHJLRQVHFRQRPLHVQDQFLDOO\IUDJLOH7KH

presence of alternative intermediation channels such as bond markets could have provided

DQDOWHUQDWLYHVRXUFHRIH[WHUQDOQDQFLQJWRWKHFRUSRUDWHVHFWRUZKHQWKHEDQNVEHJDQWR

have problems with currency and maturity mismatches in their balance sheets. ad this been

WKHFDVHWKHQHJDWLYHLPSDFWRQWKHVHFWRUVRXWVLGHRIQDQFHPLJKWKDYHEHHQOLPLWHG

7KHRUHWLFDODQGHPSLULFDODQDO\VHVVKRZWKDWWKHEHQHWVWRFDSLWDOPRELOLW\DUHHOXVLYHZKLOHWKHWDLOULVNVDQGDVVRFLDWHGFRVWVDUHYHU\UHDO$V%KDJZDWLSRLQWV

RXWIUHHWUDGHLQZLGJHWVLVQRWWKHVDPHDVIUHHWUDGHLQQDQFLDODVVHWV7KHFRVWVRI

FDSLWDOPRELOLW\DUHWKHULVNVRIVXGGHQVWRSVRUUHYHUVDOVDQGWKHWHQGHQF\RIWKHVHRZV

WRQDQFHDVVHWEXEEOHV7KHVHFRVWVDUHHVSHFLDOO\KLJKLQHFRQRPLHVWKDWGRQRWKDYH

ZHOOGHYHORSHGQDQFLDOPDUNHWV6XGGHQVWRSVDQGFDSLWDORZUHYHUVDOVDUHSDUWLFXODUO\

GLVUXSWLYHDVHYLGHQFHGE\WKHLULPSDFWLQ$VLDLQ7KHIRUPDWLRQRIDVVHWSULFH

bubbles a phenomenon that is repeatedly observed is driven by seemingly rational behavior

RIH[SHFWHGSURWPD[LPL]DWLRQ under conditions of asymmetric information. This is unstable

DQGHYHQWXDOO\OHDGVWRFRVWO\GLVUXSWLRQVDQGQDQFLDOLQVWDELOLW\

7KHSDWWHUQRIFDSLWDOLQRZVDQGRXWRZVLQWRDQGRXWRIWKH$6($14

by typeRIFDSLWDORYHULVVKRZQLQLJXUH$VXGGHQVWRSDQGUHYHUVDORIGHEWDQG

SRUWIROLRLQYHVWPHQWLQRZVZDVH[SHULHQFHGLQDQGSHUVLVWHGZHOOLQWR3RUWIROLR

LQYHVWPHQWDQGGHEWLQRZVVKRZHGDVWURQJUHERXQGLQRQO\WRH[KLELWDVXGGHQVWRS

DQGUHYHUVDOLQ6\VWHPLFVKRFNVHPDQDWLQJIURPFDSLWDORZVRQFHDJDLQPDQLIHVWHG

GXULQJWKHJOREDOQDQFLDOFULVLVRI7KHLPSDFWRIWKHJOREDOQDQFLDOFULVLVDQGFDSLWDO

RZUHYHUVDOVRQHFRQRPLFJURZWKZHUHQRWDVVHYHUHFRPSDUHGWRWKHHIIHFWVRIWKH$VLDQ

QDQFLDOFULVLV

3 Several behavioral theories attempt to explain the ormation o asset price bubbles. Interested readers may reer toShiller (2003) and Lansing (2007).

4 The ASEAN-5 is comprised o Indonesia, Malaysia, the Philippines, Singapore, and Thailand.



17/52

Figure 4: ASEAN-5 Capital Infows and Outfows by Category ($ million)

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Equity outow Equity inow Equity net

FDI outow FDI inow FDI net

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Equity

Debt outow Debt inow Debt net

40,000

20,000

0

20,000

40,000

60,000

80,000

60,000

40,000

20,000

0

20,000

40,000

60,000

30,000

20,000

10,000

0

10,000

20,000

30,000

Debt

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Direct Investment

FDI = oreign direct investment, ASEAN-5 = Indonesia, Malaysia, the Philippines, Singapore, and Thailand.Source: Authors' estimates.



18/52

&DSLWDOLQRZVDQGRXWRZVDUHKLJKO\SURF\FOLFDOZLWKQDQFLDOFULVHVDQGWHQGWR

H[KLELWLQFUHDVLQJYRODWLOLW\6KRUWWHUPFDSLWDORZVZKHWKHUVKRUWWHUPGHEWRUSRUWIROLR

LQYHVWPHQWVDUHWKHSULPDU\GULYHUVRIKLVWRULFDOXFWXDWLRQV7KHUHODWLYHO\XQGHUGHYHORSHG

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0HFKDQLVPVWKDWOHDGWRFXUUHQF\DQGQDQFLDOFULVHVDUHQXPHURXVDQGLQFOXGH

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WKHFRUSRUDWHVHFWRU2EVWIHOGDQG7D\ORUQRWHVWKDWILQDQFLDODQGLQVWLWXWLRQDO

underdevelopment including the inadequate quality of bank supervision the quality and

transparency of corporate governance the enforcement of property rights etc. contribute

to the probability of occurrence of a crisis.

7KHQDQFLDOFULVLVVSUHDGWKURXJKWKHUHJLRQVEDQNLQJV\VWHPVDVVXGGHQ

VWRSVLQFRPELQDWLRQZLWKDVVHWSULFHGHDWLRQOHGWRODUJHFXUUHQWDFFRXQWUHYHUVDOVEDQN

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of well-developed local corporate bond markets meant that the capital markets had no spare

WLUHZKHQEDQNVFRXOGQRORQJHULVVXHFUHGLWWRIXHOWKHHFRQRP\RUDORQJSHULRGDIWHUWKH

crisis large corporate borrowers which are dependent on local banks were unable to raise

funds. The crisis was instrumental in unmasking the fragility and lack of depth of the AA

QDQFLDOV\VWHP7KHUXVKWROLEHUDOL]HQDQFLDOPDUNHWVLQPDQ\FRXQWULHVLQWKHV

DQGVXQGHUWKHSUHYDLOLQJGRJPDWKDWLWLVZHOIDUHHQKDQFLQJOHGWRSHUYHUVHUHVXOWV

LQWKHDEVHQFHRILQVWLWXWLRQVDQGLQIUDVWUXFWXUHWKDWSURPRWHVQDQFLDOPDUNHWGHYHORSPHQW

7KHUHVHHPVWREHVRPHGHJUHHRIHQGRJHQHLW\DPRQJQDQFLDOFULVLVYXOQHUDELOLW\

FDSLWDODFFRXQWRSHQQHVVDQGOHYHORIGHYHORSPHQWRIORFDOQDQFLDOV\VWHPV7KHPRUH

developed the latter the less vulnerable they are as is argued to be the case of ingaporeZKLFKKDVWKHPRVWGHYHORSHGDQGRSHQQDQFLDOPDUNHWVDPRQJWKH$6($12QWKH

LSVLGHFRXQWULHVZLWKOHVVGHYHORSHGQDQFLDOPDUNHWVWHQGWREHPRUHYXOQHUDEOHWR

QDQFLDOVKRFNVDQGDUHPRUHOLNHO\WRFRQVWUDLQFURVVERUGHURZVWRPLWLJDWHULVNDQ

HXLOLEULXPSRVLWLRQDNLQWRQDQFLDODXWDUN\7KHODWWHUFRXOGOHDGWRVXERSWLPDOUHVXOWV

XQOHVVWKHFRUUHFWSROLFLHVDQGQDQFLDOLQIUDVWUXFWXUHDUHSXUVXHG



19/52

IV. THE ROLE OF CAPITAL CONTROLS

$W WKH WKHRUHWLFDO OHYHO WKH HOGVWHLQorioka puzzle and the ome Bias uzzle have

withstood innumerable efforts to overturn them. The high correlations between domesticVDYLQJDQGLQYHVWPHQWUDWHVLQRWKHUZLVHUHODWLYHO\RSHQHFRQRPLHVLQWKH2UJDQLVDWLRQIRU

(FRQRPLF&RRSHUDWLRQDQG'HYHORSPHQW2(&'LPSO\WKDWFDSLWDOLVUHODWLYHO\LPPRELOH

even in the advanced economies. This empirical regularity is inconsistent with the notion

WKDWVDYLQJVRZIURPDGYDQFHGHFRQRPLHVLQWKHIRUPRILQYHVWPHQWVLQOHVVGHYHORSHG

economies resulting in global welfare gains. This also implies that consumption smoothing

DQGULVNGLYHUVLFDWLRQDUHEHQHWVWKDWFDQQRWEHDXWRPDWLFDOO\H[SHFWHGZLWKFURVVERUGHU

FDSLWDOOLEHUDOL]DWLRQ7KHPRVWLPSRUWDQWEHQHWIURPWKHVWDQGSRLQWRIHFRQRPLFGHYHORSPHQW

is the potential for foreign direct investments into the real sector. The ucas aradox suggests

that this would not be a likely outcome.

(YHQLIWKHJDLQVIURPFDSLWDODFFRXQWRUQDQFLDOOLEHUDOL]DWLRQZHUHUHDOL]HGKRZHYHU

such gains may not be particularly large. ourinchas and eanne ) conduct a policyH[SHULPHQWRQWZRFDOLEUDWHGPRGHOVRIHFRQRPLFGHYHORSPHQWDQGQGWKDWWKHSRWHQWLDO

JDLQVIURPFDSLWDOOLEHUDOL]DWLRQDUHOLNHO\WREHVPDOOQRWH[FHHGLQJDLQFUHDVHLQUHDO

consumption given estimated parameter values in production and intertemporal elasticities

of substitution. mploying a neoclassical model akin to A. amseyCassoopmans Model

and a Macro-Mincer model with human capital and distortions they conclude that any

substantial gains arising from capital liberalization could not come from channels arising

out of the standard neoclassical model of economic development. The implication is that

QDQFLDOOLEHUDOL]DWLRQZRXOGKDYHWRLQGXFHLPSURYHPHQWVLQIDFWRUSURGXFWLYLW\LQRUGHUWR

produce substantial improvements in economic growth. Their research results imply that it

LVEHWWHUWRLQWURGXFHSROLFLHVWKDWUHGXFHGRPHVWLFGLVWRUWLRQVSULRUWRQDQFLDOOLEHUDOL]DWLRQ

in order to realize substantial gains from liberalization. hile lacking in empirical contentthe results of their study are consistent with the observation that countries with relatively

undeveloped internal markets fail to gain from cross-border capital account liberalization.

The economic performance of emerging market economies Ms) and patterns in

RZVRIFDSLWDOGXULQJ WKH$VLDQQDQFLDOFULVLVDQGWKHJOREDOQDQFLDOFULVLV

KDYHOHGWRWKHUHQHZHGLQWHUHVWLQWKHXVHIXOQHVVRIFDSLWDOFRQWUROV7KHGRJPDRIQDQFLDO

OLEHUDOL]DWLRQKDGSULPDF\LQWKHVDQGVRQWKHJURXQGVRIVXSSRVHGZHOIDUHJDLQV

arising from consumption smoothing and risk sharing but the lack of empirical evidence on

actual gains coupled with real costs of vulnerability to crises arising from sudden stops and

reversals increasingly cast doubt on its validity. There is mounting evidence that the path

5 Under the intertemporal theory o the current account and capital mobility, savings and investment should have alow correlation, since investors could borrow or lend abroad without being constrained by the amount o domesticsavings. Feldstein and Horioka (1980) ound high correlations between savings and investments in OECD countries,contrary to the prediction o theory.

6 The Home Bias Puzzle is attributable to French and Poterba (1991), and reects the fnding that equity investorstend to invest locally despite the presence o higher yielding investments and benefts rom overseas investments,contrary to the prediction o fnance theory.



20/52

WRQDQFLDOOLEHUDOL]DWLRQDQGGHYHORSPHQWZLWKRXWUHJDUGWRWKHGHJUHHRIGHYHORSPHQWRI

WKHQDQFLDOPDUNHWFRXOGEHFRVWO\

$IWHUUHFRYHULQJ IURP WKH$VLDQQDQFLDO FULVLV WKH UHJLRQVHPHUJLQJHFRQRPLHVmanaged the risk of sudden stops largely by accumulating prodigious amounts of foreign

exchange reserves. This costly strategy involves sterilization by the regions central banks

which end up holding low-yielding foreign currency and issuing relatively high-yielding debt. The

SURFHVVRIPDVVLYHFDSLWDOLQRZVDQGVWHULOL]DWLRQE\WKHUHJLRQVFHQWUDOEDQNVWRSUHYHQW

LQDWLRQPHUHO\UHLQIRUFHVWKHLQHIFLHQWUHF\FOLQJRI$VLDQVDYLQJV,WVUHLQIRUFLQJHIIHFWV

RQLQHIFLHQWUHLQWHUPHGLDWLRQRI$VLDQVDYLQJVQRWZLWKVWDQGLQJWKHUHDUHOLPLWVWRUHVHUYH

DFFXPXODWLRQDQGVWHULOL]DWLRQJLYHQWKHHQVXLQJVFDOEXUGHQRILQWHUHVWSD\PHQWVRQORFDO

currency sovereign bonds such that other measures will eventually have to be resorted to.

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LQFOXGLQJWKHQDWXUHDQGSHUVLVWHQFHRIVKRFNVWR WKHV\VWHP0HQGR]DQGVWKDW

RXWSXWYRODWLOLW\LQFUHDVHVZLWKQDQFLDOLQWHJUDWLRQZKHQVKRFNVDUHODUJHDQGSHUVLVWHQW%XFK'RSNHDQG3LHUG]LRFKQGWKDWPRQHWDU\SROLF\VKRFNVLQFUHDVHWKHYRODWLOLW\

RIRXWSXWEXWORZHUWKDWRIFRQVXPSWLRQ7KH\DOVRQGWKDWVFDOSROLF\VKRFNVJLYHULVHWR

opposite results.

There is some evidence that not only was consumption smoothing not achieved

in some cases but actually became more volatile for some countries. ose rasad and

7HUURQHVQGWKDWWKHYRODWLOLW\RIFRQVXPSWLRQJURZWKUHODWLYHWRLQFRPHJURZWK

DFWXDOO\LQFUHDVHGIRUVRPHPLGUDQJHQDQFLDOO\LQWHJUDWHGHFRQRPLHVWKDWH[SHULHQFHG

SDUWLFXODUO\ODUJHLQRZVLQWKHV7KLVLVFRQVLVWHQWZLWKWKHREVHUYHGSURF\FOLFDOLW\RI

FDSLWDORZVDVZHOODVWKUHVKROGHIIHFWVZKHUHUHYHUVDOVWHQGWRRFFXUDIWHULQRZVUHDFK

DFHUWDLQOHYHO,QFRQWUDVWOHVVQDQFLDOO\LQWHJUDWHGGHYHORSLQJFRXQWULHVH[SHULHQFHGDreduction in their volatility of consumption growth relative to income growth in similar periods.

+RZFDQWKHULVNRILQFUHDVHGYXOQHUDELOLW\WRQDQFLDOFULVHVLQWKHFRXUVHRILQFUHDVHG

QDQFLDORSHQQHVVEHUHFRQFLOHGZLWKWKHREHFWLYHRILQFUHDVHGUHJLRQDOQDQFLDOLQWHJUDWLRQ

DVSDUWRI$6($1VQDQFLDOGHYHORSPHQWVWUDWHJ\"

,WLVSURSRVHGWKDWDVHOHFWLYHXVHRIFDSLWDOFRQWUROV XQGHUSUHGHQHGDQGPXWXDOO\

agreed upon rules and conditions for implementation be included in the AA countries

stabilization toolkits. ithout cooperation the use of such controls by one country could give

rise to negative externalities on neighboring countries exacerbate the perverse pattern of

FDSLWDORZVDQGSRVVLEO\JLYHULVHWRJUHDWHUPLVDOORFDWLRQRIFDSLWDODQGXQZLVHLQYHVWPHQWV

7 The traditional deinition o capital controls rely on policies that aect cross-border capital transactions whichdiscriminate on the basis o residence. Broader capital management measures espoused more recently by the IMFinclude those that do not do so.



21/52

7KHQRWLRQRIFDSLWDOFRQWUROVLVQRWQHZ$WLWVLQFHSWLRQHYHQWKH,0UHFRJQL]HG

WKDWIXOOPRELOLW\RIFDSLWDOLVQRWQHFHVVDULO\ZHOIDUHHQKDQFLQJ2VWU\HWDOQRWH

WKDWHYHQWKH,0V$UWLFOHVRI$JUHHPHQWUHFRJQL]HWKDWPHPEHUVPD\JHQHUDOO\H[HUFLVH

controls as are necessary to regulate international capital movements subject to their Article,9REOLJDWLRQVRQ,0VXUYHLOODQFH

,WLVDUJXHGWKDWFDSLWDOFRQWUROVQHHGQRWEHDQDQDWKHPDWRQDQFLDOGHYHORSPHQW

under conditions where their use is coordinated harmonized and exercised under a set of

multilaterally agreed upon rules. This is necessary to militate against the use of controls for

SXUSRVHVRWKHUWKDQQDQFLDOVWDELOL]DWLRQ7KHUHLVDQHHGWRGLVFRXUDJHLWVXVHDVDWRRO

for strategic advantage and gains arising out of beggar thy neighbor trade and exchange

rate policies.

istorically capital controls have been used in the AA largely to help authorities

manage the exchange rate and maintain the independence of monetary policy. They were

OLNHZLVHXVHGE\0DOD\VLDDQG7KDLODQGGXULQJWKH$VLDQQDQFLDOFULVLVLQDQDWWHPSWWRFRQWUROH[FHVVLYHRXWRZVDQGPLQLPL]HWKHHIIHFWVRIWKHUHYHUVDOVLQFDSLWDORZV7KDLODQG

LQWURGXFHGFRQWUROVRQFDSLWDOLQRZVXUJHVLQ WKURXJKDXQUHPXQHUDWHG

reserve requirement. Chile used the same instrument at the turn of the century.

6WXGLHVRQWKHHIIHFWLYHQHVVRIFRQWUROVVKRZPL[HGUHVXOWV,QDUHYLHZRIHPSLULFDO

VWXGLHVRQWKHHIIHFWLYHQHVVRIFDSLWDOFRQWUROV+XWFKLVRQQGVWKDWWKHHYLGHQFH

LVPL[HGRQWKHLUHIIHFWRQYROXPHVRIRXWRZVDQGLQRZVDOEHLWWKHUHVHHPVWREHD

JHQHUDOQGLQJWKDWFRQWUROVWHQGWRDOWHUWKHFRPSRVLWLRQ*RFKRFR%DXWLVWDRQJZDQLFK

DQGHHRQJZDQLFKDQGRKSDLERRQDQGLPDQG


22/52

6XUJHVLQFDSLWDOLQRZVWHQGWRQDQFHDVVHWSULFHEXEEOHVHVSHFLDOO\LQWKHSURSHUW\

VHFWRU,QDWLRQWDUJHWLQJFHQWUDOEDQNVLQWKHUHJLRQ,QGRQHVLDWKH3KLOLSSLQHVDQG7KDLODQG

have remained reluctant to use monetary policy as a tool against asset price bubbles and

primarily use macroprudential measures such as ceilings on loan-to-value ratios propertycooling measures and reserve requirements.

2VWU\HWDOSURSRVHDIUDPHZRUNLQZKLFKFDSLWDOFRQWUROVPD\EHXVHGLQ

conjunction with macroeconomic and prudential policies in order to address potential problems

DVVRFLDWHGZLWKVXUJHVLQFDSLWDORZV7KLVSUHOLPLQDU\IUDPHZRUNLVVXJJHVWHGDVDXVHIXO

starting point in harmonizing any effort to arrive at a regional framework for a multilateral

DJUHHPHQWRQWKHXVHRIFDSLWDORZVWRJXDUGDJDLQVWQDQFLDOYXOQHUDELOLW\HYHQDVHIIRUWV

to undertake regionwide liberalization is being implemented. owever this framework is seen

E\PDQ\HPHUJLQJHFRQRPLHVDVDZHGLQWKDWLWDOORZVWKHXVHRIFDSLWDOFRQWUROPHDVXUHV

only as a last resort when every other measure has failed. owever at that point capital

controls are less likely to work.

,QWKHLUVXUYH\RIWKHOLWHUDWXUHRQPDQDJLQJFDSLWDOLQIORZVDZDLDQG7DNDJL

DUJXHWKDWWKHUHDUHQRVLPSOHUXOHVRQWKHSDFHDQGVHXHQFLQJRIFDSLWDODFFRXQW

liberalization and that certain preconditions must exist in order to address macroeconomic

DQGQDQFLDOVWDELOLW\ULVNVDVVRFLDWHGZLWKFURVVERUGHURZV7KH\DUJXHWKDWHOHPHQWVRI

VRXQGPDFURHFRQRPLFSROLF\LQFOXGLQJVFDOGLVFLSOLQHSUXGHQWH[WHUQDOGHEWPDQDJHPHQW

DH[LEOHH[FKDQJHUDWHDQGWKHWUDQVSDUHQWFRQGXFWRIPRQHWDU\DQGH[FKDQJHSROLFLHV

must be put in place. These preconditions are consistent with the framework proposed by

2VWU\HWDO$PXOWLODWHUDODSSURDFKLVKRZHYHUUHLWHUDWHGVLQFHHDFKPHPEHUVWDWH

KDVDGLIIHUHQWVWDWHRIGRPHVWLFQDQFLDOPDUNHWGHYHORSPHQWDQGLVFRQVHXHQWO\H[SRVHG

WRYDU\LQJOHYHOVRIQDQFLDOIUDJLOLW\

V. FINANCIAL MARKET DEVELOPMENT IN ASEAN COUNTRIES

7KHLQHIFLHQWLQWHUPHGLDWLRQRI$VLDQVDYLQJVDULVLQJIURPWKHUHJLRQVUHODWLYHO\XQGHUGHYHORSHG

QDQFLDOV\VWHPVDQGWKHULVNVDVVRFLDWHGZLWKYRODWLOHFDSLWDORZVUHXLUHVDSURDFWLYH

GHYHORSPHQWDSSURDFK7KHEHQHWVIURPLQFUHDVLQJWKHGHSWKRIQDQFLDOPDUNHWVLQ$VLD

in terms of reduced exposure to the tail risks of capital mobility as well as in providing a

PRUHHIFLHQWSODWIRUPIRULQWHUPHGLDWLQJ$6($1VDYLQJVVKRXOGSURYLGHWKHVHHFRQRPLHV

enough incentives to push such an initiative.

A. The Asian Financial Crisis and Developments in ASEAN Depository Institutions

7KHEDQNFHQWULFQDWXUHRI$VLDQQDQFLDOV\VWHPVLQWKHUXQXSWRWKH$VLDQQDQFLDO

crisis was exacerbated by the fact that banks were generally badly managed and poorly

supervised Mohanty and Turner ). The relatively high regional and global) growth



23/52

UDWHVIURPWRWRJHWKHUZLWKOLEHUDOL]HGFURVVERUGHUFDSLWDORZVHQFRXUDJHG

banks to incur foreign currency debt with relatively short maturities to take advantage of the

LQFUHDVHGORFDOGHPDQGIRUFUHGLW(DVHRIDFFHVVWRIRUHLJQFXUUHQF\GHQRPLQDWHGQDQFLQJ

encouraged banks to take unhedged positions and engage in excessive risk taking. ThisSUDFWLFHOHIWWKHPYXOQHUDEOHWRWKHVXGGHQVWRSRIGHEWLQRZVDQGVXEVHXHQWUHYHUVDOVLQ

6LQFHQRQEDQNUPVDUHKHDYLO\GHSHQGHQWRQWKHORFDOEDQNLQJV\VWHPIRUGHEW

QDQFLQJWKLVVHWWKHVWDJHIRUWKHWUDQVPLVVLRQRIWKHHQVXLQJQDQFLDOFULVLVLQWRWKHUHDO

side of the economy resulting in severe economic contractions in most AA economies.

etail deposit growth in the AA except for Cambodia exceeded gross loans in

DQGDOWKRXJKWKHORDQWRGHSRVLWUDWLRVIRU,QGRQHVLDWKHDR3'5DQG7KDLODQG

ZHQWXSGXULQJWKHJOREDOQDQFLDOFULVLV5HH7KLVLVUHHFWLYHRIEDQNVLQFUHDVHG

ULVNDYHUVLRQDIWHUWKHQDQFLDOFULVLVZLWKWKHFRQVHXHQFHRIUHGXFHGUHOLDQFHRQ

wholesale funding. ,QDGGLWLRQORFDOEDQNVLQWHUQDWLRQDOOHQGLQJLQFUHDVHGVLJQLFDQWO\

beginning in hand in hand with the increase in deposits in international banks. This

LPSOLHVWKDWFODLPVLQ%DQNRI,QWHUQDWLRQDO6HWWOHPHQWV%,6UHSRUWLQJEDQNVH[FHHGHGWKHLUOLDELOLWLHVLQPRVW\HDUV,QWHUQDWLRQDOEDQNVDOVRWHQGHGWROHQGWR$VLDQEDQNVLQORFDO

FXUUHQF\VXFKWKDWDFXUUHQF\PLVPDWFKZDVDYRLGHG,QJHQHUDOWKHOLXLGLW\RI$VLDQ

banks including those in the AA dramatically improved at the turn of the century.

,QDGGLWLRQWRLQFUHDVHGULVNDYHUVLRQLQWKHDIWHUPDWKRIWKH$VLDQQDQFLDOFULVLV

favorable macroeconomic conditions and micro-prudential regulations resulted in strong

EDODQFHVKHHWSRVLWLRQVZLWKVLJQLFDQWO\OHVVUHOLDQFHRQFDSLWDORZVRXWVLGHRIWKHUHJLRQ

0RKDQW\DQG7XUQHU,PSURYHGDFFHVVWRLQWHUQDWLRQDOFDSLWDOPDUNHWVDOVRDOORZHG

QRQEDQNUPVWRGLUHFWO\REWDLQFURVVERUGHUORDQVWKHUHE\VXEVWDQWLDOO\UHGXFLQJWKHUROH

RIEDQNVLQLQWHUPHGLDWLQJFDSLWDORZV$VDUHVXOWWKH$6($1EDQNLQJV\VWHPVEHFDPH

even more resilient against external shocks.

1RQEDQNUPVDUHOLNHZLVHEHJLQQLQJWRWDSRYHUVHDVPDUNHWVIRUH[WHUQDOQDQFLQJ

implying a potential for corporate bond market development within the region. The combined

effect of faster growth in deposits relative to the demand for bank credit the availability of

local currency loans from foreign banks and the available revenue alternatives in the form

RIVRYHUHLJQERQGVJDYHEDQNVLQWKH$6($1(0(VDVXIFLHQWOLXLGLW\FXVKLRQWRHPSOR\

countercyclical lending.

Bank lending in the region has also become more inclusive with retail consumer

GHEWULVLQJVXEVWDQWLDOO\LQ,QGRQHVLDDQG0DOD\VLD3ULRUWRWKH$VLDQQDQFLDOFULVLV$6($1

banks generally engaged in a one-way intermediation process where household savings

were transformed into bank deposits and eventually converted into corporate credit. pon

UHFRYHU\IURPWKHFULVLVWKHUHZDVDQLQFUHDVHLQWZRZD\LQWHUPHGLDWLRQDQGWKHUHZDVrapid development in consumer banking Mohanty and Turner ). This rise in mortgage

8 These prudential measures include single and group borrower limits as well as tighter provisions on the dispensationo credit to shareholders, ocers, and related interests. Basel I and II ensured that capital adequacy is sucient andthat risks are careully monitored and controlled.



24/52

and consumer lending is indicative of improved avenues for consumption smoothing on the

part of households as well as reduced exposures to trade shocks on the part of banks.

B. Deepening ASEAN Financial Systems

LQDQFLDOPDUNHWGHYHORSPHQWDPRQJWKH$6($1HFRQRPLHVKDVEHHQXQHYHQ,WKDVEHHQ

XQHYHQDFURVVPDUNHWVDQGXQHYHQDFURVVHFRQRPLHVRUPRVWRIWKHVHHFRQRPLHVWKH

EDQNLQJVHFWRUVDQGVWRFNPDUNHWVDUHDOUHDG\ZHOOGHYHORSHG([FHSWIRUWKHYHVPDOOHU

$6($1HFRQRPLHV WKHJRYHUQPHQWERQGPDUNHWVDUHDOVR IDLUO\ ZHOOGHYHORSHG ,QQRQH

RIWKHHFRQRPLHVDUHWKHFRUSRUDWHERQGPDUNHWVVXIFLHQWO\ZHOOGHYHORSHGWRFRQWULEXWH

VLJQLFDQWO\WRHFRQRPLFJURZWKDQGVWDELOLW\

5REXVWQDQFLDOPDUNHWVDQGV\VWHPVUHXLUHPXOWLSOHFKDQQHOVRIQDQFLQJVXFK

that it is imperative that bond markets are developed in the AA yntelberg Ma and

5HPRORQD*DUFLD+HUUHUR:RROGULGJHDQG


25/52

Table 2: Financial Depth o ASEAN+3 Countries Market Size as a Percentage o GDP

(as o end 2010)

Domestic Bank Credit Stock Market Debt Securities Market

Brunei Darussalamb 32.0 Cambodia 23.3 Indonesia 35.6 51.0 13.2Lao PDR Malaysia 132.2 171.7 100.8Myanmar Philippines 52.1 83.4 33.9Singapore 85.7 290.6 57.8Thailand 109.0 87.1 70.7Viet Namb 123.0 37.0 China, People's Rep. o 147.6 46.2 24.8Japan 237.6 70.1 251.6Korea, Rep. o 103.2 108.4 110.3Memo:

United States 104.4 117.9 172.9

Euro areac 156.5 55.2 111.5... = Data not available, GDP = gross domestic product, PPP = purchasing power parity.a For domestic bank credit, end-2009.b Weighted averages based on 2005 GDP and PPP exchanges rates.Sources: Sta calculations using data rom International Financial Statistics (IMF 2011a), World Economic Outlook(IMF 2011b), and World

Federation o Exchanges (2011).

:KHQLWFRPHVWRQDQFLDOPDUNHWVLWLVVDLGWKDWLQ$VLDHXLW\LVNLQJ,QGHHG

WKHVWRFNPDUNHWVLQPRVWRI WKH$6($1HFRQRPLHVDUHWKULYLQJ$VVKRZQ LQ7DEOH

in the epublic of orea Malaysia and ingapore the ratio of stock market capitalization

WR*'3H[FHHGV,QFRQWUDVW%UXQHL'DUXVVDODP&DPERGLDDQG0\DQPDUKDYHQR

stock markets to speak of. Trading in the ao ecurities xchange started only in anuary

with two listed companies. Because of its wealth and its easy access to the ingaporePDUNHW%UXQHL'DUXVVDODPSUREDEO\KDVQRQHHGIRULWVRZQVWRFNPDUNHWRU&DPERGLD

DQG0\DQPDUKRZHYHUDVWRFNPDUNHWFDQEHFRQVLGHUHGWREHORZKDQJLQJIUXLWIRUQDQFLDO

market development.

:KLOHJHQHUDOO\QRWDVZHOOGHYHORSHGDVWKHVWRFNPDUNHWVVLJQLFDQWGRPHVWLFGHEW

PDUNHWVDOVRH[LVWLQPRVWRIWKH$6($1HFRQRPLHV$VVKRZQLQ7DEOHRQO\YHRIWKH

economies lack such markets namely Brunei arussalam Cambodia ao Myanmar

DQG9LHW1DP1RQHWKHOHVVHYHQIRUWKHRWKHUHFRQRPLHVLWLVRQO\WKHJRYHUQPHQWGHEW

markets that are well developed. As discussed further below the corporate debt markets

remain much less well developed.



26/52

Table 3: Outstanding Bonds by Category ($ billion)

2000 2010 Average Growth per Annum

Corporate Government Total Corporate Government Total Corporate Government Total

Indonesia 2.4 51.2 53.6 11.6 81.9 93.5 38 6 7Malaysia 31.4 28.4 59.8 111.9 128 239.9 26 35 30Philippines 0.2 20.7 20.9 2.3 61.7 64.0 105 20 21Singapore 17.0 25.0 42.0 26.0 102.8 128.8 5 31 21

Thailand 14.1 16.7 30.8 59.5 166.1 225.6 32 89 63Total 65.1 142 207.1 211.3 540.5 751.8 22 28 26

Source: Sta calculations using Bloomberg and World Federation o Exchanges data.

7KHYDOXHRIFRUSRUDWHGHEWVHFXULWLHVLQWKH$6($1LQZDVRQO\ELOOLRQ

ZKHUHDVWKHWRWDOYDOXHRIGRPHVWLFEDQNFUHGLWVXUSDVVHGWULOOLRQ2IWKHRXWVWDQGLQJ

ELOOLRQRIERQGLVVXDQFHVDVRIDSSUR[LPDWHO\ZHUHVRYHUHLJQERQGV

Malaysia has the biggest outstanding value of corporate bonds at close to billion in

7KDLODQGVRXWVWDQGLQJYDOXHRIELOOLRQLVDIDUVHFRQG7KH3KLOLSSLQHVKDV

WKHVPDOOHVWYROXPHRILVVXDQFHVDWELOOLRQ7KHFRPSDUDWLYHVL]HRIJRYHUQPHQWDQG

FRUSRUDWHERQGPDUNHWVLQWKH$6($1LVVKRZQLQLJXUH

Figure 5: Outstanding Government versus Corporate Bonds, year-end 2010 ($ billion)

20

0

40

60

80

100

120

140

160

180

Indonesia Malaysia Philippines Singapore Thailand

Government Corporate

Source: Sta calculations using Bloomberg and World Federation o Exchanges data.

$FXUVRU\H[DPLQDWLRQRIKLVWRULFDOERQGPDUNHWYROXPHVIRUWKH$6($1DQG$6($1

LQLJXUH UHYHDOVWKDWZKLOHFRUSRUDWHERQGVDUHJURZLQJWKHJURZWKDQGDEVRUSWLRQRI

sovereign issuances outstripped the growth of corporate bonds. The growth differentials

resulted in a gradual decline in the composition of corporate bonds relative to the total from

DSSUR[LPDWHO\LQWRLQ

7KHDYHUDJHJURZWKUDWHVRIFRUSRUDWHERQGLVVXDQFHLQ,QGRQHVLDDQGWKH3KLOLSSLQHV

DUHVLJQLILFDQWO\KLJKHUSRVWLQJDYHUDJHSHUDQQXPJURZWKUDWHVRIDQG

UHVSHFWLYHO\IRU7KHFDYHDWLVWKDWWKHVHFRXQWULHVKDGVXEVWDQWLDOO\VPDOOHU

volumes of outstanding bonds in . This is particularly true for the hilippines which

only had million of outstanding corporate bonds in . The continued dominance of

EDQNVLVLOOXVWUDWHGE\WKHIROORZLQJFKDUWVLQLJXUH



27/52

Figure 6: Domestic Bank Credits and Outstanding Local Currency Bonds ($ billion)

0

500

1,000

1,500

2,000

2,500

3,000

3,500

0

5,000

10,000

15,000

20,000

25,000

30,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Domestic Bank Credit

ASEAN+3ASEAN (rhs)

0

100

200

300

400

500

600

700

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

Outstanding Asian Local Currency Bonds

ASEAN+3 CorporateASEAN Corp (rhs)

ASEAN+3 GovernmentASEAN Govt (rhs)

Notes: ASEAN includes Brunei Darussalam, Cambodia, Indonesia, the Lao PDR, Malaysia, Myanmar, the Philippines, Singapore, Thailand,and Viet Nam; ASEAN+3 includes the PRC, Japan, and the Republic o Korea.

Sources: Data on domestic bank credit romInternational Financial Statistics

(IMF 2012a); data on outstanding Asian local currencybonds rom Asian Bonds Online, available: asianbondsonline.adb.org/



28/52

A quick examination of the right hand side axes reveals the disparity in the relative

volumes of domestic credit and outstanding bond issuances in the AA. ote further that

WKHOHIWKDQGVLGHD[HVGHQRWLQJWKH$6($1SRLQWVWRDVPDOOHUJDSEHWZHHQEDQNFUHGLW

and bond issuances implying that the ratio of bank credit to outstanding bonds is smallerfor the C apan and the epublic of orea.

The extent of bank dominance is likewise seen in Table 4. ote that the share of

EDQNDVVHWVWRWKHWRWDOVL]HRI WKHQDQFHVHFWRULVVLJQLFDQWO\KLJKHUWKDQWKHVKDUHRI

GHEWVHFXULWLHV,QFRPSDULVRQWKHVKDUHRIGHEWVHFXULWLHVLQDSDQLVPXFKELJJHUUHODWLYH

to the share of debt securities. The gap between the two debt classes is also smaller for

WKH5HSXEOLFRIRUHD7KHFRPSDUDWLYHJXUHVIRUWKH86EDQNDVVHWDQGGHEWVHFXULWLHV

indicate that debt securities are twice as large as bank debt heng ).

There is no bank sector information for Brunei arussalam and Myanmar and

WKH\KDYHQRVWRFNH[FKDQJHVDVRI2FWREHU7KHVWRFNPDUNHWVRI&DPERGLDDQG

the ao only opened in anuary and uly respectively; and stock marketFDSLWDOL]DWLRQDQGERQGPDUNHWSULFLQJGDWDDUHQRW\HWDYDLODEOH2IWKHSHULSKHUDO$6($1

FRXQWULHV9LHW1DPVHHPVWRKDYHWKHPRVWDGYDQFHGQDQFLDOPDUNHW1HYHUWKHOHVVLWV

EDQNDVVHWVDQGVWRFNPDUNHWFDSLWDOL]DWLRQDVDSHUFHQWDJHRI*'3DUHVLJQLFDQWO\ORZHU

than those in the AA-.

Table 4: Global Finance Sector Indicators, 2010 (% o assets)

Bank Asset, Stock Market

Capitalization, and Debt

Securities ($ billion)

Share o Bank

Assets

(%)

Share o

Stock Market

Capitalization (%)

Share o Debt

Securities

(%)Indonesia 1,060 54 34 12Malaysia 1151 40 36 24

Philippines 415 37 38 25Singapore 1408 41 46 13Thailand 1054 51 26 22Brunei Darussalam -- -- -- --Cambodia 6 100 -- --Lao PDR 2 100 -- --Myanmar -- -- -- --Viet Nam 69 18 55 27ASEAN 5165 45 37 18

China, People's Rep. o 19746 71 14 16

Japan 27263 34 14 52Korea, Rep. o 4150 43 26 30ASEAN+3 56325 49 17 35

-- = Data not available, ASEAN = Association o Southeast Asian Nations, ASEAN+3 includes the ASEAN members and the PRC, Japan,and the Republic o Korea.

Notes: Debt securities includes all issuers o domestic and international securitiesCambodia and the Lao PDR have data on bank assets only; or the Lao PDR, bank assets are as o June 2010.

Sources: Sta calculations using data rom Bank or International Settlements, available: www.bis.org/statistics/bankstats.htm; WorldBank's World Development Indicators, available: data.worldbank.org/data-catalog/world-development-indicators; IMF WorldEconomic Outlook, available: www.im.org/external/pubs/t/weo/2011/02/weodata/download.aspx; CEIC Database, available:www.ceicdata.com/; World Federation o Exchanges, available: www.world-exchanges.org/statistics; Bank scope, available:www.library.hbs.edu/go/bankscope.html; and country central bank websites; all downloaded 14 September 2011.



29/52

,QWHUPVRIDVVHWGLVWULEXWLRQVIRXQGLQ7DEOHQRWHWKDWWKH$6($1LVDOVRPXFK

PRUHGHSHQGHQWRQWKHHXLWLHVPDUNHWFRPSDUHGWRWKH35&DQGDSDQDVRI,QGRQHVLD

and Thailand had the highest degree of dependence on banks whereas the hilippines was

the least dependent. Among the peripheral AA countries Cambodia and the ao DUHWRWDOO\GHSHQGHQWRQEDQNVIRUQDQFLDOLQWHUPHGLDWLRQ9LHW1DPRQWKHRWKHUKDQG

has a higher level of dependence on the equities market. hile it has the most developed

GRPHVWLFFDSLWDOPDUNHWLQWKH$6($1SHULSKHUDOFRXQWULHVLWVQDQFLDOVHFWRUVWLOOQHHGV

IXUWKHUGHYHORSPHQWWREULQJLW XSWRSDUZLWKWKH$6($1HXQJQRWHVWKDW9LHW

ams banking system is still dominated by state-owned commercial banks and that banking

VXSHUYLVLRQDQGJRYHUQDQFHQHHGWREHVLJQLFDQWO\XSJUDGHG7KHUHLVDQHHGIRUIXUWKHU

institutional development and capability building in key macroeconomic institutions.

,QFRQWUDVW6KHQJQRWHVWKDWWKHSURSRUWLRQRIGHEWVHFXULWLHVUHODWLYHWRLWV

VXPZLWKEDQNDVVHWVDQGHXLWLHVPDUNHWFDSLWDOL]DWLRQLQWKH86DQG(XURSHIRU

LVDQGUHVSHFWLYHO\7KHVKDUHRIEDQNDVVHWVLQWKH86DQG(XURSHZDV

DQGUHVSHFWLYHO\VXFKWKDW(XURSHKDVDVLJQLFDQWO\ORZOHYHORIGHSHQGHQFHRIWKHequities markets as a source of capital.

The persistence of demand for bank credit may have been due to the increased

SUHIHUHQFHIRULQWHUQDODQGH[WHUQDOHXLW\QDQFLQJJLYHQWKHLQFUHDVHGULVNDYHUVLRQDIWHU

WKHQDQFLDOFULVLV0RKDQW\DQG7XUQHUEXWDOVRH[DFHUEDWHGE\WKHSHUFHLYHG

high transactions costs of corporate bond issuance oswami and harma ).

:LWKWKHSHUVLVWHQWGRPLQDQFHRIEDQNVLQORFDOQDQFLDOPDUNHWVDQGWKHGHYHORSPHQW

of sovereign bond markets the former began to hold on to an increasing share of government

bonds in their asset portfolios effectively raising the share of liquid assets and improving

WKHLUEDODQFHVKHHWV0RKDQW\DQG7XUQHU,QDVHQVHWKHUHIRUHWKHGHYHORSPHQWRIthe regions bond markets contributed to the improvement of local banks balance sheets

DQGUHVLOLHQF\GXULQJWKHJOREDOQDQFLDOFULVLV

HOPDQHWDOQRWHWKDWPRVWFRXQWULHVLQWKH$6($1DUHDWYDULRXVVWDJHVRI

GHYHORSLQJWKHLQIUDVWUXFWXUHQHFHVVDU\WRGHHSHQWKHORFDOERQGPDUNHWV,QGRQHVLDDQG

Thailand have undertaken reforms to their market microstructures by establishing market

makers introducing modern platforms and upgrading payment and settlement systems.

2WKHU$6($1FRXQWULHVDUHOLNHZLVHLPSURYLQJWKHLU ORFDOLQIUDVWUXFWXUH WRVXSSRUWWKH

development of local bond markets. The hilippines introduced a new ecurities egulation

Code institutionalized delivery and payment through a eal Time ross ettlement ystem

DQGODXQFKHGDQLQWHUGHDOHUSODWIRUPWRHQFRXUDJHWUDGLQJRI[HGLQFRPHLQVWUXPHQWV

The recent development of deep and liquid local currency government bond markets

in the AA emerging economies now provide dependable yield curves for the pricing

of local currency corporate bonds. As shown by Chan et al. ) among the factors that

account for much of the improvement in the local currency sovereign bond markets are

the consolidation of issuances into a few benchmark maturities and the development of

critical market making structures including the rise of interdealer markets and the entry



30/52

of international interdealer brokers. The nature of these market-making structures provide

lessons for the further development of corporate bond markets in the region.

C. Market Making in the Emerging ASEAN Bond Markets

The experience of deep and liquid government bond markets in the and urope shows

that the provision of liquidity in these markets requires an active role for market makers.

These market makers do not just arise by themselves. They are often designated by the

government and are obliged to make markets by providing two-way quotes on benchmark

issues. They perform this role in exchange for certain privileges such as being able to trade

with the central bank. To be effective these market makers often trade among themselves

LQDQLQWHUGHDOHUPDUNHWZLWKWKHKHOSRILQWHUGHDOHUEURNHUV,QGHHGWKHLQWHUGHDOHUPDUNHW

is often the most active part of the government bond market and it is often where much of

price discovery takes place.

Market making structures are a strong suit of government bond markets in the$6($1HFRQRPLHV7KHQDWXUHRIPDUNHWPDNLQJLQWKHVHPDUNHWVKDVWHQGHGWR IROORZ

the example of the Treasury market and the nited ingdoms gilts market. As shown

LQ7DEOHHDFKRIWKHHPHUJLQJ$6($1PDUNHWVWKH$6($1PDUNHWVH[FOXGLQJWKDW

of apan) has between designated market makers. ach market has at least a few

interdealer voice brokers strongly indicative of the existence of a fairly active interdealer

market.

Table 5: Market Making in Emerging Asian Government Bond Markets

Jurisdiction Market Makers Interdealer Voice Brokers

China, People'sRep. o

50 primary dealers or the People's Bank oChina Open Market Operations (two oreignbanks); 23 market dealers in the interbankbond market (three oreign banks); and threecompanies providing brokering services or theinterbank bond market

Shanghai CFETS-ICAP, Tullet Prebon SITICOLtd., Pingan Tradition International MoneyBroking Co. Ltd.

Indonesia 18 primary dealers (fve oreign banks) BNI Securities, Danareksa Sekuritas, MegaCapital Indonesia, OSK Nusadana Securities,Reliance Securities, Trimegah Securities Tbk

Korea, Rep. o 20 primary dealers (two oreign banks) Korea Interdealer Broker Corporation (KIDB),Korea Money Brokerage Corporation (KMB)

Malaysia 12 principal dealers (six locally incorporatedoreign banks)

An (Tullett Prebon), Amanah ButlerMalaysia Sdn Bhd, First TAZ TraditionSdn Bhd, Harlows & MGI Sdn Bhd, ForexEnterprise Sdn Bhd, KAF-Astley & PearceSdn Bhd

Philippines 42 government securities dealers (nine oreignbanks and fnancial institutions)

AFS Philippines Inc., ICAP Philippines Inc.,Tradition Financial Services, Tullett PrebonPhilippines Inc.

Singapore 13 principal dealers (10 oreign banks) ICAP, Tullett Prebon, Tradition

Thailand 9 primary dealers (our oreign banks) ICAP, Wallstreet Tullett Prebon

Note: Seven markets as o February 2011.Sources: BIS, Chan et al. (2011).



31/52

0DUNHWOLXLGLW\GRHVQRWVHHPWRUHXLUHPDQ\GHVLJQDWHGPDUNHWPDNHUV,QWKH

PRUHOLXLGRIWKHHPHUJLQJ$6($1PDUNHWVWKHUHWHQGWREHRQO\ designated

PDUNHWPDNHUV,QGRQHVLDKDVSULPDU\GHDOHUVWKH5HSXEOLFRIRUHDSULPDU\

GHDOHUV0DOD\VLDSULQFLSDOGHDOHUV6LQJDSRUHSULQFLSDOGHDOHUVDQG7KDLODQGprimary dealers. The C and the hilippines rely on the most number of market makers.

7KH3HRSOHV%DQNRI&KLQD3%2&KDVGHVLJQDWHGSULPDU\GHDOHUVDVFRXQWHUSDUWLHV

IRULWVRSHQPDUNHWRSHUDWLRQVDQGPDUNHWGHDOHUVLQWKHLQWHUEDQNERQGPDUNHW7KH

Bureau of Treasury of the hilippines has designated 4 government securities dealers.

,QWHUGHDOHUYRLFHEURNHUVQRZRSHUDWHLQWKHODUJHU$6($1PDUNHWV7KHHQWU\RI

WKHVHEURNHUVHQWDLOVODUJH[HGFRVWVDQGWKH\ZRXOGQRWKDYHFRPHLIWKHPDUNHWVGLG

not have serious potential for depth and liquidity. uch brokers have played critical roles in

WKH[HGLQFRPHPDUNHWVRIWKH86DQGWKH8QLWHGLQJGRPE\HQVXULQJH[DQWHDQRQ\PLW\

and ex post transparency in bringing counterparties together. The leading global interdealer

EURNHUVLQFOXGH%*&,&$37XOOHWW3UHERQ*,DQG7UDGLWLRQ$WOHDVWRQHRUWZRRIWKHP

RSHUDWH LQWKHPRUHOLXLGRI WKH$6($1PDUNHWV6RPHRIWKHPDUNHWVUHO\ODUJHO\RQORFDOLQWHUGHDOHUEURNHUV7KLVLVHVSHFLDOO\WKHFDVHLQ,QGRQHVLDDQG0DOD\VLD

The entry of interdealer brokers is key to the development of corporate bond markets

LQWKH$6($1DQGLQHPHUJLQJ$VLDQFRXQWULHVDVDZKROHLJXUHVKRZVWKHDFFHOHUDWLRQ

RIFRUSRUDWHERQGLVVXDQFHLQ$VLDQHPHUJLQJPDUNHWVLQDQG

Figure 7: Corporate Bond Issuance in Asian Emerging Markets (52 issuers, in $ billion)

125

100

75

50

25

0

Local currencyForeign currency

2005 2006 2007 2008 2009 20102

Source: Sta calculations using data rom International Financing Review(Thomson Reuters 20052010).

:KLOHWKHDJJUHJDWHYROXPHVDUHVWLOOVLJQLFDQWO\VPDOOHUWKDQWKRVHLQDGYDQFHGeconomies the rapid growth of local currency bond issuances in the past years is indicative

WKDWQDQFHPDUNHWGHYHORSPHQWLQLWLDWLYHVDUH\LHOGLQJVRPHSRVLWLYHUHVXOWV



32/52

D. Why Size Matters or Deep and Liquid Markets

The regional imperative for market development recognizes that size is important. McCauley

and emolona ) and yntelberg Ma and emolona ) have emphasized theLPSRUWDQFHRI PDUNHWVL]H LQGHYHORSLQJGHHSDQGOLXLGQDQFLDOPDUNHWV7KHSRWHQWLDO

QXPEHURILVVXHUVDQGEX\HUVLQVRPHFRXQWULHVPD\EHDVLJQLFDQWEDUULHUWRZDUGIDVWHU

development of local currency corporate bonds for some countries in the region. The authors

observe that markets with smaller liquidity are often characterized by a small investor base

lacking in market transparency and with a poor information infrastructure. ichengreen and

uengnaruemitchai ) also point out that structural factors like the lack of critical size in

capital market issuance and the historical dependence on the banking sector also explain the

weak growth of corporate bond markets in Asia. oswami and harma ) point out that

secondary liquidity in the AA has a high degree of dependence on foreign investors who

access the regional markets through access products distributed by foreign intermediaries.

:KLOHWKHGHJUHHRIQDQFLDOGHHSHQLQJLQGLFDWHVWKHLPSRUWDQFHRIDQDQFLDOVHFWRUto the economy the absolute size of the sector is often an indicator of how effective the

VHFWRULV LQSHUIRUPLQJLWVUROHRI LQWHUPHGLDWLQJVDYLQJVDQG LQYHVWPHQWDUJHUQDQFLDO

PDUNHWVDUHPRUHOLNHO\WREHGHHSHUDQGPRUHOLXLGWKDQVPDOOHUPDUNHWV,IDVGLVFXVVHG

LQWKHQH[WVHFWLRQQHWZRUNH[WHUQDOLWLHVDUHWKHVRXUFHRIGHSWKDQGOLXLGLW\LQQDQFLDO

markets then there will be a size threshold beyond which a critical mass will allow a market

to develop viable depth and liquidity. onetheless exceeding the size threshold seems to

EHDQHFHVVDU\EXWQRWVXIFLHQWFRQGLWLRQIRUQDQFLDOPDUNHWGHYHORSPHQWDFWRUVRWKHU

WKDQVL]HDUHFOHDUO\DOVRLPSRUWDQW7DEOHVKRZVWKHDEVROXWHVL]HRIWKHYDULRXVQDQFLDO

VHFWRUVIRUWKH$6($1

Table 6: Size o Capital Markets in ASEAN+3 Countries, end-2010 ($ billion)Stock Market Government Bond Market Corporate Bond Market

Brunei Darussalam Cambodia China, People's Rep. o 2,716 1,623 674Indonesia 360 82 12Lao PDR Malaysia 409 128 112Myanmar Philippines 157 62 2Singapore 647 103 26Thailand 278 166 59Viet Nam 38 Japan 3,828 11,632 2,102Korea, Rep. o 1,092 475 636

Memo:United States 17,283 11,152 14,197Euro area 5,638 7,205 5,915

... = Data not available, ASEAN+3 = composed o ASEAN member countries and the PRC, Japan, and the Republic o Korea.Sources: Sta calculations using data rom Bloomberg, available: www.bloomberg.com/; Bank or International Settlements, available:

www.bis.org/statistics/bankstats.htm; and World Federation o Exchanges, available: www.world-exchanges.org/statistics, alldownloaded 14 September 2011.



33/52

xperience suggests that the size threshold for stock markets is not very high. As

VKRZQLQ7DEOHDPRQJWKH$6($1VWRFNPDUNHWVWKHPDUNHWVLQWKH3KLOLSSLQHVDQG

9LHW1DPDUHWKHVPDOOHVW:LWKDFDSLWDOL]DWLRQRIELOOLRQDVRIWKHHQGRIWKH

hilippine stock market appears to be already well developed and has apparently been soIRUPDQ\\HDUV:LWKDFDSLWDOL]DWLRQRIELOOLRQWKH9LHW1DPVWRFNPDUNHWLVQRW\HW

considered to be well developed. The size threshold for a critical mass in stock markets

would appear to be somewhere between the sizes of those two markets probably closer to

WKDWRI9LHW1DPWKDQWKDWRIWKH3KLOLSSLQHV7KH9LHW1DPPDUNHWPD\QHHGWROLVWXVWD

few more companies to exceed the size threshold. Beyond this the government can focus

on other important aspects of market reform. uch aspects are beyond the scope of this

study. The other small AA economies have a longer way to go.

The size threshold for government bond markets does not appear to be very high

HLWKHU,QUHFHQW\HDUVWKHODUJHU$6($1FRXQWULHVKDYHVXFFHHGHGLQGHYHORSLQJGHHSDQG

liquid local-currency government bond markets. These markets now provide dependable yield

curves for the pricing of local-currency corporate bonds. As shown in Table the smallestamong these markets is that of the hilippines with an outstanding amount of government

ERQGVRIELOOLRQDVRIWKHHQGRI$%,6UHSRUWLQE\&KDQHWDOSURYLGHV

DQDVVHVVPHQWWKDWFRQVLGHUVHYHQWKLVPDUNHWWREHGHHSDQGOLXLG,QWKH3KLOLSSLQHVWKLV

was achieved in part through the consolidation of issuance in a few benchmark maturities.

ome evidence for the markets liquidity is found in the market making structures which

was discussed earlier in this section.

The size threshold for corporate bond markets appears to be much higher than that

IRUJRYHUQPHQWERQGPDUNHWV$VVKRZQLQ7DEOHDPRQJWKH$6($1HFRQRPLHVWKH

largest corporate bond markets are those of the C apan and the epublic of orea.

:LWKDPRXQWVRXWVWDQGLQJDVRIWKHHQGRIRIELOOLRQWULOOLRQDQGELOOLRQrespectively not one is considered deep and liquid. onetheless it is possible that with the

right market microstructure these markets are big enough to become deep and liquid. uch

a microstructure would likely include interdealer markets that ensure ex ante anonymity and

ex post transparency.

7KHUHDUHWZRFRUSRUDWHERQGPDUNHWVWKDWDUHZHOONQRZQWREHGHHSDQGOLXLGWKRVH

of the and the uro area. But these markets are far larger than those in Asia. The

PDUNHWLVWULOOLRQLQVL]HDQGWKH(XURSHDQPDUNHWWULOOLRQ,WLVOLNHO\WKDWWKHVL]H

threshold needed for a critical mass is much smaller than these. onetheless in Asia it also

seems likely that reaching such a threshold will require a market that is regional in scope.

,IFRUSRUDWHERQGPDUNHWVLQ$VLDDUHWRSHUIRUPWKHLUUROHVDVDVSDUHWLUHIRUWKHcapital markets and as a mechanism for rectifying the perverse way in which the regions

savings are recycled into costly investments it is important to recognize that only a regional

effort will allow these markets to reach the required size threshold.



34/52

VI. WHY REGIONAL INSTEAD OF GLOBAL?

THE TUG-OF-WAR BETWEEN THE GEOGRAPHY OF INFORMATION

AND NETWORK EXTERNALITIES

0DQ\RIWKHXVXDODUJXPHQWVIRUWKHUHJLRQDOLQWHJUDWLRQRIQDQFLDOPDUNHWVZRXOGDSSO\

with even more force for the global integration of such markets. Two such arguments are

HFRQRPLHVRIVFDOHDQGWKHGLYHUVLFDWLRQRIULVNV(FRQRPLHVRIVFDOHVXSSRVHGO\EULQJ

GHSWKDQGOLXLGLW\WRPDUNHWV'LYHUVLFDWLRQDOORZVLQYHVWRUVWR VHHNFHUWDLQOHYHOVRI

investment returns without taking on greater risk. lobal integration would take greater

DGYDQWDJHRIVXFKHFRQRPLHVRIVFDOHDQGDOORZZLGHUGLYHUVLFDWLRQRI ULVNVWKDQZRXOG

regional integration.

onetheless there is a case for regional integration rather than global integration.

This case rests on the trade-off between the geography of information and the critical mass

required by network externalities. The geography of information pulls in the direction of more

localized markets while network externalities pull toward more regional and global markets.7KHWHUPVRIWKLVWXJRIZDUYDULHVIURPRQHQDQFLDOPDUNHWWRDQRWKHU,QHPHUJLQJ$VLD

this tug-of-war makes the case for regional integration stronger for corporate bond markets

WKDQIRURWKHUQDQFLDOPDUNHWV

$WLWVURRWWKHUROHRIQDQFLDOPDUNHWVLVWRSURFHVVDQGDJJUHJDWHUHOHYDQWLQIRUPDWLRQ

obtained by market participants. The actual allocation of capital to various investments is

the outcome of decisions made on the basis of this informational role of markets. uch an

LQIRUPDWLRQDOUROHLQYROYHVWZRGLVWLQFWGLPHQVLRQV

i) The geography of information. epending on the type of asset the cost of

obtaining that information would often be lower for investors whose geographicproximity to sources of information are closer. uch geographic proximity is

HVSHFLDOO\LPSRUWDQWIRUPDUNHWVWKDWGHSHQGRQUPVSHFLFLQIRUPDWLRQ

SDUWLFXODUO\HXLW\PDUNHWVDQGOHVVLPSRUWDQWIRUPDUNHWVWKDWGHSHQGRQ

macroeconomic information such as government bond markets.

ii) Network externalities. The processing of information requires market participants

to interact in various ways including through trading. This interaction gives

rise to the network externalities in information that is the fundamental source

of market depth and liquidity. To take effective advantage of such externalities

markets require a certain size. But once a critical mass is reached the

advantages become less compelling.

9 The 2008 ADB report on the emerging Asian regionalism, or example, states there are potentially more opportunitiesor diversifcationand thus higher risk-adjusted returnsrom investing globally. Global fnancial markets tend tobe deeper, more liquid, and more diversifed (ADB 2008, 109).



35/52

A. The Geography o Inormation or Dierent Markets

7KHHYLGHQFHIRUWKHJHRJUDSK\RI LQIRUPDWLRQLVFLUFXPVWDQWLDOEXWSHUVXDVLYH ,WFRPHV

IURPWZRERGLHVRIOLWHUDWXUH2QHERG\LVRQJUDYLW\PRGHOVRIQDQFLDORZVWKHRWKHURQthe home bias of portfolio investments. ravity models provide evidence for the geography

of information for both equity markets and international bank lending. The home bias of

portfolio investments is largely seen to be a puzzle but there is now some evidence that it

UHHFWVWKHJHRJUDSK\RILQIRUPDWLRQ

,QWKHFDVHRIHXLW\PDUNHWV3RUWHVDQG5H\H[SORUHSDQHOGDWDRQFURVV

ERUGHUHXLW\RZVEHWZHHQFRXQWULHV7KH\QGWKDWDJUDYLW\PRGHOH[SODLQVLQWHUQDWLRQDO

transactions in these assets at least as well as goods trade transactions. These transactions

depend on market size as well as trading costs. ith distance between countries as a proxy

IRULQIRUPDWLRQFRVWVWKH\QGWKHJHRJUDSK\RILQIRUPDWLRQWREHWKHPDLQGHWHUPLQDQWRI

the pattern of international transactions.

,QWKHFDVHRILQWHUQDWLRQDOEDQNOHQGLQJ(LFKHQJUHHQDQG3DUNWDJUDYLW\

PRGHOWR%,6GDWDRQFURVVERUGHUEDQNFODLPV7KH\QGWKDWLQWHUQDWLRQDOOHQGLQJIDOOVZLWK

distance and rises with common language. A common land border has little effect. These

results lead ichengreen and ark to conclude that information costs are more important

than transportation costs.

7KHUHLVYROXPLQRXVOLWHUDWXUHRQWKHKRPHELDVRIHXLW\SRUWIROLRV,QUHQFK

DQG3RWHUEDIRXQGWKDW86HXLW\LQYHVWRUVDOORFDWHGQHDUO\RIWKHLUIXQGVWRGRPHVWLF

securities although the market comprised less than half of the global market. uch a

home bias is apparently even stronger for uropean equity investors. Twenty years after

UHQFKDQG3RWHUEDSXEOLVKHGWKHLUUHVXOWVWKHKRPHELDVRIHXLW\LQYHVWRUVUHPDLQVDVpronounced as ever. This is a gross violation of modern portfolio theory that it is called the

home-bias puzzle.


36/52

is important in these acquisitions. ot only do block investors show a strong preference for

nearby companies but these investors are also more likely to involve themselves in post-

acquisition governance efforts in such companies. These governance efforts tend to succeed.

The geographically proximate target companies realize higher announcement returns andbetter post-acquisition performance than do other target companies.

To provide an insight on thegeographic distribution of investors in international bond

issues by large Asian borrowers data were collated by gleaning information from reports

on bond issues in the weekly International Financing Review Thomson euters various

\HDUV$VVKRZQ LQ7DEOHZHKDYHEHHQDEOHWRREWDLQLQIRUPDWLRQRQERQGLVVXHV

RYHUPRQWKVEHWZHHQDQXDU\DQG$XJXVWLQIRUDWRWDORIELOOLRQ7KHLVVXHUV

FRPHIURPHLJKW$6($1FRXQWULHVQDPHO\WKH35&,QGRQHVLDDSDQWKH5HSXEOLF

of orea Malaysia the hilippines ingapore and Thailand. hile the issuers include

WZRVRYHUHLJQV0DOD\VLDDQGWKH3KLOLSSLQHVPRVWRIWKHUHVWDUHFRUSRUDWHERUURZHUV

LQFOXGLQJQDQFLDOLQVWLWXWLRQV7KHFXUUHQFLHVLQZKLFKWKHERQGLVVXHVDUHGHQRPLQDWHG

are dominated by the dollar but there are also nine issues in the Chinese renminbi andone each in the apanese yen and the ingapore dollar.

Table 7: International Bond Issuance by Asian Borrowers: Geographic Distribution o

Investors, JanuaryAugust 2011 (millions)

Issue Description

Size in US

Dollars

Investors by Region (%)Month o

issuance Issuer name

Residence o

Issuer Size Currency Asia US Europe

Aug 2011National Agricultural

Cooperative Federation Korea, Rep. o 500 USD 500 58 27 15Posco Korea, Rep. o 24,526 JPY 316 41 0 36Hangzhou ZhongCe Rubber PRC 900 RMB 140 99 0 0

Jul 2011

[The People's Rep. o] China

Shanshui Cement PRC 1,500 RMB 232 99 0 1Korea Housing Finance Korea, Rep. o 500 USD 500 48 41 11Korea Hydro & Nuclear

Power Korea, Rep. o 500 USD 500 31 47 22Japan Bank or International

Cooperation Japan 2,000 USD 2,000 36 11 38Beijing Enterprises Water

Group PRC 1,000 RMB 155 99 0 0Beijing Enterprises Water

Group PRC 450 RMB 70 89 0 8Jun 2011 Zijin Mining Group PRC 280 USD 280 87 0 13

Malaysia Malaysia 1,200 USD 1,200 44 4 9Malaysia Malaysia 800 USD 800 57 15 21

May 2011 Lonking Holdings PRC 350 USD 350 47 33 20Pertamina Indonesia 1,000 USD 1,000 36 42 22

Pertamina Indonesia 500 USD 500 40 37 23Sino-Ocean Land PRC 400 USD 400 84 16 0ENN Energy Holdings PRC 750 USD 750 31 50 19Beijing Enterprises PRC 600 USD 600 51 38 11Beijing Enterprises PRC 400 USD 400 66 26 8

Apr 2011 Guangzhou R&F Properties PRC 150 USD 150 95 0 5Guangzhou R&F Properties PRC 2,612 RMB 399 97 0 3BYD PRC 1,000 RMB 153 99 0 1Zhongsheng Group PRC 1,250 RMB 191 98 0 2Export-Import Bank o Korea Korea, Rep. o 700 USD 700 50 43 7

continued



37/52

Issue Description

Size in US

Dollars

Investors by Region (%)Month o

issuance Issuer name

Residence o

Issuer Size Currency Asia US Europe

[The People's Rep. o] China

Automation Group PRC 200 USD 200 67 0 33Fueng Group PRC 300 USD 300 46 21 33SPG Land PRC 200 USD 200 100 0 0PTT Exploration

and Production Thailand 700 USD 700 30 56 14Malayan Banking Malaysia 1,000 SGD 794 100 0 0[The People's Rep. o] ChinaWind Power Group PRC 750 RMB 114 97 0 3

Mar 2011 Republic o the Philippines Philippines 1,500 USD 1,500 40 30 30Singapore

Telecommunications Singapore 600 USD 600 37 27 36Jan 2011 PCD Stores PRC 750 RMB 113 97 0 3

Texhong Textile Group PRC 200 USD 200 62 10 28

Total 17,005 53 23 18

JPY = Japanese yen, PRC = People's Republic o China, RMB = renminbi, SGD = Singapore dollars, USD = United States dollars.Note: Thirty-one issues.Source: International Financing Review(Thomson Reuters, various issues).

2XUGDWDRQ$VLDQERQGLVVXHVVKRZVRPHHYLGHQFHRIDKRPHELDVLQWKHLQWHUQDWLRQDO

FRUSRUDWHERQGPDUNHW$VVKRZQLQ7DEOHRIWKHWRWDODPRXQWRILVVXDQFHZDV

by investors from the Asian region. The next largest group of investors was from the

DFFRXQWLQJIRURIWKHWRWDO7KHJHRJUDSK\RILQIRUPDWLRQVHHPVWRDSSO\WRFRUSRUDWH

ERQGPDUNHWVXVWDVLWGRHVWRHXLW\PDUNHWV,WLVLQWHUHVWLQJWKDWLQWKHFDVHRIWKH

VRYHUHLJQLVVXHVWKHHIIHFWUHPDLQVEXWLVVRPHZKDWOHVVSURQRXQFHGRUWKH3KLOLSSLQHV

LVVXHLQ0DUFKZDVSXUFKDVHGE\$VLDQLQYHVWRUVRUWKHWZRVRYHUHLJQLVVXHV

E\0DOD\VLDLQXQHWRJHWKHUZDVE\$VLDQLQYHVWRUV7KHH[WHQWRIKRPHELDV

LVHDVLO\VHHQLQLJXUHZKLFKVKRZVWKDWRI WKHWDNHXSRIERQG LVVXDQFHVLQWKH

region from anuary to August was locally subscribed.

Figure 8: International Bond Issues by Asian Corporate Borrowers,

JanuaryAugust 2011 (%)

53.0

23.0

18.0

6.0

Asia

Europe

United States

Others

Note: 31 issues or a total o $17 billion.Source: Sta calculations using JanuaryAugust 2011 data rom International Financing Review(Thomson Reuters 2011).

Table 7. continued



38/52

A recent study by Coeurdacier and ey ) looks for evidence of home bias beyond

the equity home bias. As far as home bias in bonds an aggregate of both government and

private sector) across emerging markets is concerned their measure shows that emerging

Asia has the highest level of home bias in bonds compared with developed countries andrelative to other regions such as Central and outh America outh Africa and Central and

astern urope.

B. Two Phenomena o Network Externalities in Finance

'HSWKDQGOLXLGLW\LQQDQFLDOPDUNHWVDULVHIURPQHWZRUNH[WHUQDOLWLHV(FRQRPLGHV

suggests that in a given market the interaction of market participants within a network

produces gains for the market as a whole that add up to more than the gains of the

LQGLYLGXDOSDUWLFLSDQWV6XFKLQWHUDFWLRQDOORZVPDUNHWPDNHUVWRSURYLGHOLXLGLW\,W DOVR

HDVHVSULFHGLVFRYHU\VRWKDWSULFHVLJQDOVPD\JXLGHWKHRZRIVDYLQJVWRLQYHVWPHQWV

7KHVHH[WHUQDOLWLHVDULVHLQWZRZD\VLUVWWKH\DULVHIURPWKHLQWHUDFWLRQRIPDUNHWPDNHUV

ZKLFKH[SODLQWKHSKHQRPHQRQRIQDQFLDOFHQWHUV6HFRQGWKH\DULVHIURPWKHLQWHUDFWLRQof savers and investors within a network which explain the phenomenon of investment

banking and syndicated lending.

%DEXVDQG$OOHQDUJXHWKDWQHWZRUNH[WHUQDOLWLHVRIIVHWWKHLPSDFWRIJHRJUDSKLF

GLVWDQFHDQGLQIRUPDWLRQDV\PPHWULHVLQWKFHQWXU\(XURSHVPHUFKDQWEDQNLQJV\VWHP

WKHUHE\DOORZLQJIRUDPRUHHIFLHQWRZRIFDSLWDO&KULVWRIIHUVHQDQG6DUNLVVLDQ

on the other hand argue that there are network externalities even at the local level. These

stem from access to local information relevant in the assessment of idiosyncratic risk as well

as externalities arising from learning effects associated with interaction and learning among

PDUNHWSOD\HUV7KH\QGWKDWFLW\VL]HDQGWKHDJJORPHUDWLRQRIQDQFLDOLQWHUPHGLDULHV

ZLWKLQDORFDOLW\PDWWHUVIRUPRUHHIFLHQWLQWHUPHGLDWLRQDQGH[SODLQVWKHSUHYDOHQFHRIQDQFLDOFHQWHUV

7KHSKHQRPHQRQRIQDQFLDOFHQWHUVFDQEHIRXQGDWYDULRXVJHRJUDSKLFOHYHOV$W

WKHORFDOOHYHOWKHH[LVWHQFHRIDSUHGRPLQDQWQDQFLDOFHQWHULQWKHODUJHU$6($1FLWLHV

attests to the importance of network externalities. These centers include the alan udirman

area in akarta Ayala Avenue in Makati City henton ay in ingapore and athorn and

6LORP5RDGVLQ%DQJNRN,QWKHVHFHQWHUVQDQFLDOUPVZLOOLQJO\SD\WKHKLJKHVWRIFH

rents in the city just to be located close to each other. At the regional level ong ong

&KLQD6LQJDSRUHDQG7RN\RVHUYHDVLPSRUWDQWUHJLRQDOQDQFLDOFHQWHUVDQGWKHVHFLWLHV

FRPPDQGWKHKLJKHVWRIFHUHQWVLQWKHUHJLRQ6LQJDSRUHWHQGVWRVSHFLDOL]HLQFXUUHQF\DQG

[HGLQFRPHWUDGLQJDFWLYLW\DQGLQSULYDWHEDQNLQJ+RQJRQJ&KLQDWHQGVWRVSHFLDOL]H

in equity trading initial public offerings and mergers and acquisitions.

7KHULVHRIQDQFLDOFHQWHUVVHHPVWREHGULYHQE\ DSDUWLFXODUIRUPRIQHWZRUN

H[WHUQDOLWLHVWKRVHWKDWVWHPIURPWKHLQWHUDFWLRQRIPDUNHWPDNHUVLQLQWHUGHDOHUPDUNHWV

uch interdealer markets are especially important in fixed-income markets such as

JRYHUQPHQWERQGPDUNHWVDQGFXUUHQF\PDUNHWV7KHGHDOHUVLQWKHVHPDUNHWVQGLWWR



39/52

their advantage to be located close to each other because of the importance of face-to-

IDFHFRPPXQLFDWLRQWREHDEOH WRKHDUWKHVRFDOOHGEX]]RI WKHPDUNHW+RQJXELN

DQG6WHLQIRUH[DPSOHQGHYLGHQFHLQWKHVLJQLFDQFHRIWKLVEX]]LQWKHKROGLQJV

and trades of money managers. There seems to be something special in the hobnobbingby market participants in being able to observe body language something that is just not

available in internet communication.

The other phenomenon of network externalities is about the information network of

borrowers and investors. This phenomenon has more to do with the geographic reach of

QDQFLDOPDUNHWVWKDQZLWKWKHLQWHUDFWLRQRIPDUNHWPDNHUVDPRQJWKHPVHOYHV0RUULVRQ

DQG:LOKHOPVXJJHVWWKDWLQYHVWPHQWEDQNVGHULYHDFULWLFDOLQIRUPDWLRQDODGYDQWDJH

in underwriting securities from their access to a network of investors located in a wide

geographic area. This informational advantage seems to have been exploited even by

PHUFKDQWEDQNVLQWKHWKFHQWXU\6FKQDEHODQG6KLQSURYLGHHYLGHQFHWKDW

merchant banks in Amsterdam in that century were part of a network that included merchant

banks in amburg and Berlin. This network allowed funds to be raised in Amsterdam and

invested all over russia.

C. The Tug-o-War in Dierent Financial Markets

7KHYLDELOLW\RIDQDQFLDOPDUNHWRIDJLYHQVL]HGHSHQGVRQ WKHWXJRIZDUEHWZHHQWKH

JHRJUDSK\RILQIRUPDWLRQDQGQHWZRUNH[WHUQDOLWLHV$VLOOXVWUDWHGLQLJXUHLQPDUNHWVWKDW

are too small the total geographic costs of information would dominate the total economic

gains from network externalities. As the markets get larger the total costs of information rise

because the average distance between investors and investments lengthens. An important

FKDUDFWHULVWLFRIQHWZRUNVKRZHYHULVWKHH[LVWHQFHRIDFULWLFDOPDVV2QFHWKHPDUNHW

expands to reach this critical size the externalities become important and the total gainsfrom the network rise rather sharply. These gains begin to overcome the geographic costs

RILQIRUPDWLRQ,WLVRQO\DWWKLVVWDJHWKDWDQDQFLDOPDUNHWEHFRPHVYLDEOHDVDQLPSRUWDQW

source of value to the economy.

Figure 9: Tug o War between Geography o Inormation and Network Externalities

G

ainsand

Costs

CriticalMass

RegionalMarket

GlobalMarket

Size oMarket

Gains rom networksInormation costs

Source: Authors' representation.



40/52

,QWKHODUJHU$6($1HFRQRPLHVWKHVWRFNPDUNHWVDQGJRYHUQPHQWERQGPDUNHWV

have evidently achieved the critical mass even while remaining purely domestic markets.

:LWKWKHULJKWPLFURVWUXFWXUHVLQSODFHWKHVHPDUNHWVKDYHEHFRPHYLDEOHQDQFLDOPDUNHWV

This is clearly not the case for the domestic corporate bond markets. These markets

have remained illiquid and they raise funds for only the highest rated issuers usually utilities

DQGXDVLJRYHUQPHQWFRPSDQLHV7KHORZHUUDWHGERUURZHUVLQWKH35&,QGRQHVLDWKH

epublic of orea Malaysia and the hilippines often go abroad to issue in the global

dollar corporate bond market rather than in the domestic markets. The issues listed on Table

DUHH[DPSOHVRIVXFKERUURZLQJDFWLYLW\:KLOHPRVWRIWKHORFDOFRUSRUDWHERQGPDUNHWV

LQWKH$6($1FRXQWULHVKDYHQRWDWWDLQHGWKHFULWLFDOPDVVWREHYLDEOHWKHJOREDO86

dollar market certainly has.

There are good reasons to believe that a regional corporate bond market in Asia could

be large enough to reach the critical mass required by network externalities especially if that

PDUNHWLQFOXGHVWKH35&DQGWKH5HSXEOLFRIRUHD,QWKHJOREDOFUHGLWPDUNHWVRQHRIWKHmost actively traded instruments is an Asian regional index the iTraxx Asia ex-apan index

ZKLFKLVDFRQWUDFWEDVHGRQFUHGLWGHIDXOWVZDSV&'6IRURIWKHODUJHVWERUURZHUVLQ

HPHUJLQJ$VLD'XULQJWKHUVWZHHNRI6HSWHPEHUDORQHWKHWUDGLQJYROXPHIRUWKLV

FRQWUDFWZDVELOOLRQLQQRWLRQDODPRXQWV,WLVQRWDEOHWKDWWKHRWKHUFRPSDUDEO\DFWLYHO\

traded credit instruments are also regional C indices rather than global ones. The two most

DFWLYHO\WUDGHGFUHGLWLQVWUXPHQWVLQWKHZRUOGDUHWKH'&'1RUWK$PHULFDQ,QYHVWPHQW

*UDGH,QGH[EDVHGRQ&'6FRQWUDFWVRQ1RUWK$PHULFDQERUURZHUVDQGWKHL7UD[[

(XURSH,QGH[VLPLODUO\EDVHGRQ&'6FRQWUDFWVRQ(XURSHDQERUURZHUV7KHUHLVQR

actively traded global C index.

,QWKHFRUSRUDWHERQGPDUNHWVLQFOXGLQJDERUURZHUQDPHLQDQDFWLYHO\WUDGHG&'6LQGH[LVFULWLFDOIRUOLXLGLW\,WLVDQDORJRXVWROLVWLQJDFR

going regional: how to deepen asean's financial markets

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