FUNDING AND INVESTMENT
Emerging Asian Economies Increasingly Attracting Foreign Capital
April 17, 2008
Prathima Rajan, Celent

In recent years, Asia-Pacific countries such as China, Hong Kong, India, Taiwan, South Korea and Singapore have seen greater than ever inflow of foreign capital, especially from the US and European countries. Economic development together with favourable regulatory reforms and technological up-gradation are the main reasons for increasing foreign capital inflow. This change has transformed the Asia-Pacific region into a haven for foreign investors. The fallout from the sub-prime crisis may somewhat dampen foreign investment in Asia-Pacific temporarily but Celent believes that, over the long term, the trend towards an increasing share of Asian assets in global investment portfolios will be unchanged.

Emerging Asia saw 9% growth in GDP over the last year, fuelled by India and China. Short-term GDP growth forecasts of the market range from 4.5 to 9%, compared to 2% to 3% for the US and Europe. As a result of growth in economy, the Asia-Pacific region also saw an increase in market capitalisation. Hong Kong gathered highest market capitalisation in the region (US$1715bn), with as much as twice that of the next biggest stock exchange (China). The market capitalisation of China's stock exchanges has more than doubled over one year. The growth in India, Hong Kong, Korea and Singapore exchanges has been around 48-63% over the past year.

Emerging markets have seen either stable or increasing stock market indices since 2003. Some of the markets, like Hong Kong, India, and Taiwan, have proved better performers than developed countries.

Regulatory reforms in these regions (except China) are favoring foreign institutional investors (FIIs) and thereby encouraging capital inflows. China is still rigid on foreign investors; therefore foreign investors in China either take the IPO or convertable bonds (CB) route to enter China's capital market. On the other hand, Korea is very open to foreign investors, with around 20,635 FIIs.

Technology transformation in these regions has resulted in operational efficiency. Constant system upgrades have equipped these markets for more efficient and innovative products in future. Shanghai Stock Exchange (SSE) has adopted Next Generation Trading System (NGTS) to aim at improving efficiency, support trading of more products and minimise risk. NTGS is said to have increased trading capacity by nearly 100% and is capable of executing 63 million trades per day with a peak capacity of 20,000 transactions per second.

Each of these markets has adopted technology that is best suited to their customers, market size, and execution methods for smooth operations. Upgrading technology has minimised execution time and thereby enabled an increasing number of executions per second. Fully automatic buying and selling has also made trading more transparent and efficient.

Recent times have seen these target markets with sustained foreign portfolio investments, making it one of the key global trends. The US and Europe (primarily the UK) account for 50-75% of the net foreign inflows in each of these markets.

Primary Market

Primary equities markets are dominated by domestic players in terms of underwriting. Primary market issues in Asia have risen dramatically in recent years. IPOs and follow-on issues for the target markets rose from a total of US$55.8bn in 2005 to an estimated US$123.6bn in 2007. Although fallout from the sub-prime crisis may slow this trend, Celent believes IPO activity will continue to rise for the foreseeable future. Domestic investors accounted for an estimated 60.2% of the total capital raised in 2007. Foreign participation in primary market is extremely limited, especially in China where the foreign investors invest less than 1% due to rigid entry norms. In the other markets, foreign investors provided from 10.4% (Korea) to 42% (Singapore) of total capital.

European investors provided an estimated 9.9% and US sources provided 6.5% of the total capital raised in 2006. In other words, the US and Europe accounted for close to half of the foreign investment in primary issues in 2006. Celent predicts that the share of US and European investment in these Asian countries will expand, increasing to 23% in 2008. This represents an annual growth for combined US and European investment of 43% between 2005 and 2008.

Foreign brokerages are responding to this situation by either acquiring or partnering with local investment banks to gain greater access to the market. In India, for example, DSP acquired 90% share holding in Merrill Lynch and became DSPML to gain foothold in the Indian market.

Secondary Markets

In 2006, foreign institutional investors invested a net of US$49bn into the secondary markets. Excluding Korea, where there was a net outflow, the investments total around US$62bn into the other markets - the highest for any emerging economic region.

Activity in the secondary equities markets has also seen strong growth in the recent years. Trading in equities in the target markets surged from an estimated US$3.4 trillion in 2005 to US$8.9 trillion in 2007. US and European investors accounted for an estimated 15.9% of overall trading value in these markets in 2007. Celent expects the share of US and European investors to expand to 25.9% of total trading in 2008

Foreign investors trade actively in all markets except China, where regulatory restrictions and the existence of a proxy market in Hong Kong keep foreigners' share of trading to less than 2%. In 2007, Celent estimated that foreign investment accounted for 19.1% (Taiwan) to 60.0% (Singapore) of trading in each market.

Foreign investors are playing a significant role in boosting this demand in a number of markets. European and US investor interest in Asia has been driven not only by the short-term strong performance of many Asian equi¬ties markets but also more fundamentally by the high growth of Asia's emerging economies.

In general, compared to local firms, foreign firms have advantages in electronic trading, research, global investment portfolio and customised service. The competition from FIIs will help local firms improve overall service standards.

As a result of liberalised entry norms in the Asia-Pacific region, the target markets are expected to see increased foreign participation and thereby greater demand for Asia-based assets.

Relaxing regulatory norms will see some more foreign participation and thus result in greater demand for Asia-based assets. China, especially is set to see some major changes in this direction: CSRC claims it will restart approving new joint venture brokerage houses; the total quota for QFIIs will increase to US$30bn; and QFIIs will get quota for futures investment. All these changes will result in increased foreign inflows.

The market structure will see some change in the coming three to five years. The further opening of the mainland China market will change the market in Hong Kong, thus influencing some of the markets in the Asia region, like Singapore and Taiwan.

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