by Parag Khanna
To avoid the growing risk of high US dollar–denominated debt, many Asian governments are issuing large amounts of sovereign debt in their own currencies rather than US dollars, with investors lining up to buy. China accounts for about half of Asia’s debt issuance.22 Foreigners own only about 2 percent of China’s sovereign debt, but China has indicated that it would be comfortable with about 15 percent foreign holdings and has given the green light to offshore renminbi “panda bonds” being issued by banks such as the United Kingdom’s Standard Chartered. This could mean an additional $3 trillion in liquidity by 2025 to support China’s continuing investments at home and abroad.23 China’s deleveraging is an opportunity for foreign investors: the crackdown on excessive bank borrowing, shadow banking, and even microlending has opened the door to foreign financial institutions to provide loans to Chinese customers. China’s new central bank governor is pushing through reforms that will lift restrictions (with promises to eliminate them) on the percentage of joint ventures foreigners can own and caps on foreign stakes in Chinese financial firms, while allowing qualified foreigners to invest in A-class shares.
Saudi Arabia and the UAE have also raised tens of billions of dollars in bond offerings while cutting subsidies to trim their budget deficits. In 2017, the Philippines issued a popular twenty-five-year bond offering, nearly half of which was taken up by European investors, with one-third going to Asians and the remainder to Americans. Overall, with Asian governments holding most of their own debt in local currencies rather than US dollars (except for Indonesia), they can keep interest rates low and deleverage passively. And with high growth and savings, most Asian economies can comfortably manage their current levels of debt servicing. This is why most of Asia doesn’t belong in the antiquated catchall category of “emerging markets” with countries such as Argentina that are perpetually on international life support by the IMF.
Other significant measures are harbingers of deeper Asian financial integration. Asia’s cross-border portfolio investment surged fourfold from $3 trillion in 2001 to more than $12 trillion in 2015, yet still only 20 percent of cross-border portfolio investment is intraregional (versus 60 percent in Europe).24 Even though financial services remains a strategically protected sector in most of Asia, financial jurisdictions are harmonizing regulations so that derivatives can be traded and cleared on regional platforms, banks have greater access to operate in each other’s markets, stock exchanges are connecting, disclosure standards are converging so companies can raise debt and equity more easily across borders, and regulators are granting fund managers pan-Asian “passports” to attract investment.25
These moves have supported an enormous expansion in Asia’s corporate bond markets. Traditionally, bond markets have provided less than 20 percent of Asian corporate financing, far behind that provided by banks and equity. (Banks alone have represented as much as 80 percent of total corporate debt in East Asia.) Furthermore, Asians have preferred to invest in their own markets through “round-tripping,” meaning deferring to Western fund managers who allocated far more to Western stocks than regional markets. But in the coming years, Asian savings will flow far more into Asian investments than into Western ones. The value of the US stock market doesn’t reflect underlying fundamentals of growth, nor does the weight of US companies in the MSCI World Index, which is currently greater than the US GDP. Meanwhile, for Japan, China, and India, the ratio of equities to GDP lies between 40 and 70 percent. Given the size of Asia’s financial, industrial, and technology conglomerates, there is enormous scope for them to securitize their assets. Asian bond markets are now expanding at a rate of 25 percent per year. Hong Kong’s Hang Seng Index was the best-performing of 2017, while that same year the US Standard & Poor’s 500 Index was only the thirty-third best-performing in the world. Most forecasters predict that Asian stock exchanges will deliver the highest growth in the decade ahead. Also, Asian ratings agencies have emerged in response to their Western counterparts’ crisis of legitimacy, providing more robust data for investors looking to allocate more capital to Asia. Analysts project China’s asset management industry to grow from today’s $3 trillion to $15 trillion by 2025 based on the assumption that families will invest 10 percent of their household savings in financial assets (versus 4 percent today), while ASEAN’s asset management industry should reach $4 trillion. From banks and breweries to construction companies and real estate, more and more ASEAN companies are launching IPOs.
Asian countries have eased their extreme caution about opening their capital accounts to foreign portfolio capital inflows, and Western investors are rushing in. Within two decades, Asian companies have gone from being dependent on borrowing from Western banks to becoming those banks’ most coveted clients for their IPOs. Alibaba’s 2014 IPO in New York was the largest in history at $25 billion, and Asian tech IPOs such as Singapore’s SEA Group and China’s Rise Education have become critical to generating the fees Wall Street banks crave. China now has more than fifty “unicorn” companies with billion dollar–plus valuations (slightly less than the United States), while India has about a dozen and ASEAN just under ten, with many more such pre-IPO companies gathering steam.
The global asset management industry is only about 5 percent exposed to Asia, something Western institutional investors—from asset managers and pension funds to family offices—are scrambling to correct as they search for high-yield fixed-income investments such as Asian currencies, sovereign debt, and corporate bonds. Tencent, Alibaba, and Baidu already rank among the largest companies in the world by market cap, but their rapid expansion of customer base and services makes them attractive as core elements of a Western retiree’s portfolio to augment the struggling blue-chip companies such as GE and HP. Now that MSCI includes both Chinese and Saudi Arabian domestic shares in its emerging-markets index, trillions of dollars worth of active and passive funds will expand their Asian portfolios. China has launched Bond Connect and Stock Connect programs to encourage global investors to come into its financial sector. The Shanghai-based Lufax has opened an offshoot in Singapore specifically to partner with foreign investors seeking exposure to China’s fintech market. With Saudi Aramco deciding to launch the majority of its listed shares on Riyadh’s stock exchange (rather than in New York, London, or Hong Kong), many foreign institutional investors will raise their self-imposed limits on buying Asian equities.
The same goes for emerging- and frontier-market indices, which are dominated by Bangladesh, Vietnam, and other large-population Asian countries. When MSCI upgraded Pakistan from frontier-market to emerging-market status in 2016, the trading volume of MSCI’s Pakistan ETF tripled and its value has been rallying steadily since. Then there was an intense competition to buy the Karachi Stock Exchange (now part of the Pakistan Stock Exchange), whose top one hundred companies have collectively returned 20 percent annually. The Shanghai Stock Exchange bought a 40 percent stake in the Karachi Stock Exchange (and a large stake in the Dhaka Stock Exchange as well). Asia is underpriced given rising demand and lower-than-perceived risk. Recent rating downgrades have spurred a necessary restructuring across Asian markets while also suppressing stock prices and price-to-earnings multiples, creating attractive buying opportunities. Across Asia, stock exchanges that have had only basic listings are now offering far more attractive public equities in telecoms, banks, real estate, technology, and other sectors. They also increasingly demand rigorous reporting on corporate governance, more independent directors, and compliance with environmental and social standards. Both shareholder and stakeholder interests are being taken into account.
Shifting toward flexible currency exchange rates has given Asian governments more room to maneuver and made their markets more attractive. Weaker economies used to try to control their currency value like a game of Monopoly in which the cash can’t be used on any other board. When I first went to Uzbekistan nearly twenty years ago, both my jacket and pants pockets were stuffed with wads of the nearly worthless soum. Now the currency is conve
rtible and stable, and Uzbekistan’s growth rate of 8 percent is one of the world’s highest. Arab and Asian investors are flying into and out of Tashkent weekly, looking to invest in real estate and other sectors. The demise in 2016 of the country’s Soviet-era strongman, Islam Karimov, has been followed not by chaos but by economic pragmatism in the mold of its larger but less populous neighbor Kazakhstan. From India to Vietnam to Mongolia, numerous Asian countries have recently put themselves through painful currency reforms that have paved the way for economic stability and heightened investor interest.
This surge of Asian and global capital into the region will bridge the large gap in lending to “Main Street” businesses serving billions of Asians. So, too, will nontraditional or alternative lending models such as peer-to-peer (P2P) and balance-sheet lending. China’s 2,200 P2P lenders (led by Dianrong, the Lending Club of China) comprise a market valued at $100 billion. In India, P2P lending is estimated to reach $8.8 billion by 2020. Similar operations are growing fast in Southeast Asia. But with Asian banks, nonbank financial institutions, and fintech representing a rapidly growing share of global financial assets and new regulations relatively untested, Asia could be the next epicenter of a global financial crisis. Westerners therefore need to better understand how Asian regulations and restrictions operate. Many Western fund managers scrutinize Asian corporate investor calls just as closely as they monitor Warren Buffett’s Berkshire Hathaway shareholder meetings.
Asian governments have realized that privatizing state-owned companies will also lead to substantial new inflows of investment into Asian assets, bringing in capital to serve the needs of burgeoning populations in ways they can no longer afford alone. Countries are selling off assets to compensate for low oil prices, demonstrate the discipline necessary to attract greater foreign investment, or both. They are recycling assets, leasing old infrastructure to private investors and using the revenues to finance new infrastructure, thus avoiding raising taxes. The Gulf economies still depend on oil revenues to finance their spending, but to provide the capital necessary to boost their economies they need to fund long-term economic diversification. Saudi Arabia’s national oil, mineral, and engineering companies have crowded out the private sector since the country’s 1970s oil boom, paying wages so high that nobody wanted to be an entrepreneur. But as the country cracks down on the royal family’s profligacy and strategizes a shift from merely pumping oil to producing exports, private enterprise will grow. Iran, too, is privatizing as it seeks to reduce the dominant role of corrupt and inefficient Islamic Revolutionary Guard Corps–linked companies. India, Thailand, and the Philippines are privatizing everything from airlines to dairies to casinos to raise capital and stimulate commercial activity in industrial and services sectors. As in China, India’s very high levels of corporate debt (both financial and nonfinancial) are forcing the government to relax foreign investment regulations and accelerate privatization, which together should lead to better corporate governance. India is also reforming outdated policies such as bankruptcy laws by setting a timeline for liquidating failed companies so the private sector can restructure without government delays or devoting resources to unnecessary bailouts.
Even in state-capitalist systems such as China, Russia, and Vietnam, inefficient state-owned companies are being restructured to list shares for investors and be more independently run. China has successfully used its State-owned Assets Supervision and Administration Commission (SASAC) to restructure many state-owned entities (SOEs) in shipbuilding, steel, machinery, electronics, and other areas into functional (and even profitable) entities. The result is not fully private companies but rather Singapore-style government-linked companies (GLCs) in which state-financed investment funds have large stakes. Asia’s mixed capitalism is evolving from backstopping inefficient behemoths to supporting firms’ acquisition of competitors and their technologies. The Chinese government has encouraged major companies such as Baidu and Alibaba to buy substantial stakes in China Unicom and other state-owned companies and bring in their technological know-how to retool them to be better performers. This is how Asia’s oligopolies of oversized conglomerates are making way for a new generation of firms operating across the traditional boundaries of finance and technology.
Following the Singapore model, other Asian countries are wisely seeking investment and technology from foreign investors rather than tax revenues. FDI across Asia is creating hundreds of thousands of jobs annually in electronics, information technology, and automotive, real estate, and business services, raising productivity and adding value across the economy. There are many anchor tenants now in Asia’s skyscrapers, from Riyadh to Shanghai. This has attracted the global private equity (PE) industry to Asia, which has already surpassed Europe as the second largest destination for private equity (just behind the United States), with one-fourth of all global PE capital devoted to the region.26 Four of the world’s largest PE funds are Asian—SoftBank’s Vision Funds in Japan, China State-Owned Capital Venture Investment Fund, the Sino-Singapore Connectivity Private Equity Fund Management Company, and the China Internet Investment Fund—each with $100 billion–plus in capital to deploy. Baring Private Equity Asia (BPEA) is the regional veteran and the largest Asian PE fund fully based in Asia, with forty companies in its portfolio. US PE firms have been doubling annually the number of deals they complete in Asia. The American PE fund KKR has bought fifteen companies in Asia since 2016 across the education, financial services, health care, insurance, and hospitality sectors. TPG, another US fund, has expanded its Asia portfolio to thirty-seven companies in the same sectors as well as real estate, tech, and energy. Bain Capital also has significant investments in Asia, including Japan Wind Development Company (JWD). European funds such as EQT have been investing in Asia for over a decade, with the Swiss-based Partners Group raising its Asia portfolio to 17 percent of its total and rising with each new investment. Western and Asian funds are also collaborating to upgrade and expand regional businesses. In 2017, the New York–based Global Infrastructure Partners and China Investment Corporation (CIC) together bought a portfolio of Asian wind and solar energy projects from Singapore-based Equis for $3.7 billion. As the luster comes off post-Brexit London, Indian industrial magnates who sell their plants to Singaporeans or other Asian investors have been parking their huge payouts in Dubai.
As Asian companies professionalize and scale region-wide in logistics, tourism, real estate, and outsourcing, they are expanding well beyond their home markets. The fastest-growing vectors of sales are Asians to Asians. India’s $100 billion software market caters to Western tech giants such as Microsoft and SAP but also competes with them as Tata Consultancy Services (TCS) and Infosys provide affordable quality IT services worldwide. Price and taste play important roles as well. McDonald’s and KFC, for example, have enormously successful food outlets in the United States and worldwide, but in the Philippines, neither can dislodge the fried chicken chain Jollibee, which has three times as many outlets as KFC and lines stretching around the corners—all the while expanding across Southeast Asia and the Gulf, where it competes with both of them (as well as opening several restaurants in the United States). Vitasoy, a small Hong Kong company that began selling soy milk to combat malnutrition, now operates in forty countries. Western retailers salivate at the prospects of Asia’s urbanizing middle-class consumers, but China’s 400 million millennials aren’t nearly as attracted to Western brands as their parents. The more than 1 billion South and Southeast Asians who aspire to own refrigerators are buying them from Haier, LG, and Godrej. Simply put: Asians are buying far more Asian goods.
Though this is worrying for Western companies, it makes Asia much more attractive for the venture capital (VC) industry. Though Silicon Valley is still a first mover in many domains, it represents only 17 percent of annual global VC spending. In 2016, US venture investment fell by $10 billion to $76 billion.27 Meanwhile, according to PricewaterhouseCoopers, in 2017 Asia had more investment in tech start-ups than the
United States did. US VCs are part of the reason why. Many of the biggest, such as Sequoia Capital and Accel, have planted roots in Asia to branch out beyond the mature and overhyped US market. Their presence has inspired Asia-focused VCs, such as Golden Gate Ventures and East Ventures, while government-backed Asian funds have taken stakes in Silicon Valley incubators and accelerators, as Abu Dhabi Financial Group has done with the San Francisco–based 500 Startups. This rise of ever more regional start-ups has compelled Asian sovereign wealth funds such as Singapore’s GIC to increase their Asian tech portfolios beyond their superstar investments Alibaba and Xiaomi. The Boston-based tech PE firm TA Associates had zero international staff a decade ago, but now half its employees and investments are outside the United States, especially from Mumbai to Hong Kong.
Talent is also in ever greater circulation between the West and Asia and within the region itself. When Pavel Durov, often referred to as Russia’s Mark Zuckerberg, moved the communications app Telegram out of Russia, he shifted operations to Dubai and Singapore. The Singaporean Yinglan Tan, a graduate of Carnegie Mellon, was until recently the venture capital fund Sequoia Capital’s lead partner covering Southeast Asia and India before he left to launch his own frontier tech-focused fund called Insignia Venture Partners, for which he had more than $100 million in commitments within weeks. “Today the perfect pan-Asian tech company,” Yinglan tells me, “has a Singaporean headquarters, Taiwanese engineers, Vietnamese UX designers, Indonesia as its target market—and IPOs in Hong Kong.” By operating inside Asia, he also knows that even though the United States and China are leading deep tech innovation, the other Asian countries are not vassals. Instead, local joint ventures are crucial to harnessing big data and making it relevant for building new products and services. The Jakarta-based e-commerce company Sale Stock Indonesia is using artificial intelligence (AI) to figure out how to cut costs on products that don’t sell well by screening out designs that an algorithm designates as likely to fail.
