Capital Market Integration in South Asia

Realizing the SAARC Opportunity

Sourajit Aiyer

• Publisher: Elsevier
• Year: 2016
• ISBN:
  9780081019160
• Topic: Negocios y empresa
• Subtopic: Marketing
• Index: Marketing

Capital Market Integration in South Asia: Realizing the SAARC Opportunity discusses the potential Capital Market Products/Activities which can create closer inter-linkage of the South Asian capital markets and help local/global investors benefit from this economic opportunity.

While some ideas may be implementable now; others have future promise as the regional markets further mature. The book demonstrates both retail and institutional investor interest in this combined high-growth region by offering scope for yield, diversification and risk mitigation, maximized upside from multiple growth markets, minimized downside through low-correlation constituents, and more.

The book's core theme addresses the challenges towards deepening the awareness and acceptability of regional economies. Only when this happens will the asset flows increase into the regional market products, providing scale-up that will aid viability for these products.

• Presents unconventional ideas for converting SAARC's unique opportunities into ideas for capital markets
• Includes socioeconomic issues as a part of the discussion
• Offers a unique perspective on how the region's economic opportunities can be translated into actual products
• Includes numerous charts and figures on South Asia's economic state, its financial opportunities, and projected growth

Chapter 1

Introduction

Abstract

This chapter is an introduction, using an observation of Lee Kuan Yew, the father of modern Singapore who is widely credited for converting Singapore into an economic success, to describe the ASEAN market. The section says that the same observation holds true even for the SAARC region today and makes a comparison of the challenges being faced in the other regional economic groups today. It discusses the basic objective of this book to create closer interlinkage of SAARC’s capital markets, and the ideas, which include both conventional and unconventional thinking. It stresses that India benefits from the returns and low correlation of the SAARC’s frontier markets, while those markets benefit from India’s size. Thus, a SAARC asset class portfolio can increase the upside from multiple growth/return enablers, while minimizing the downside risk due to the low correlation of its constituents.

Keywords

Lee Kuan Yew; ASEAN; SAARC; South Asia; economic bloc; integration; economy; frontier market

Lee Kuan Yew, credited for converting Singapore into an economic success, once described ASEAN, the South-East Asian group, as “Unpromising Start, Promising Future.” This apt phrase can also describe SAARC, the South Asian group. SAARC has seen few successes, but geopolitical issues slowed progress. Global institutional investors are using acronyms for groups of developing countries which are homogeneous in stage of development and outlook—BRICS, MINT, Next-11, CIVETS, along with the existing regional groups—ASEAN, GCC, East Europe, CIS, Pacific Alliance, East Africa. But all is not rosy with these groups, which can impact their economic outlook. China’s slowdown is impacting commodity exporters like Brazil, social issues are creating rifts in South Africa, Russian geopolitics is impacting East Europe, Turkey’s proximity to Syria is a disruptor, Nigeria and Kenya are seeing terror threats, Chinese activity in South China Sea sandbars is raising hackles in Vietnam and Philippines, Thailand’s economy has slowed since the coup, GCC states have power-tussles with Egypt and Iran, while some of ASEAN’s fast growing economies comprise only a small proportion of its aggregate.

At a time when the outlook of various regional groups seems uncertain, SAARC does not look so bad. SAARC is a unique combination of sizable Emerging (EM) and Frontier (FM) markets, which have low correlation to each other. Return on Equity and Margins of top companies in Pakistan and Bangladesh has improved relative to those of India, while Sri Lankan companies have seen buoyant topline growth. This should help counter volatility or cyclical growth of single-market exposure. Investors may argue why they should look at SAARC asset class, and it is better to look at India or FMs separately. India benefits from the returns and low correlation of SAARC’s FMs, while the FMs benefit from India’s size. Thus, a SAARC portfolio can increase the upside from multiple growth/return enablers, while minimizing the downside due to low-correlation constituents.

SAARC’s economic growth from 2014 to 2020 will outpace all the regions mentioned earlier, as per IMF estimates. The incremental size it will add to its economy is next only to BRICS and Next-11. SAARC ranks high in savings growth, savings rate, and aggregate savings, as of 2020. Savings has a direct bearing on investment flows. Capital market penetration is quite low in SAARC, so depth can increase further. Income is more evenly distributed in SAARC except for East Europe, so investor breadth can widen. SAARC has young demographics with a near absence of social benefits, i.e., a longer earning life with the need for long-term, inflation-beating investments. Incremental capital formation is amongst the highest in SAARC, indicating creation of economic activity, jobs, income, and savings. Not only is SAARC a large consumer base, it is building production capabilities in both factory and knowledge sectors. Proximity of the SAARC countries to each other gives it a locational advantage for regional value-chain opportunities. Companies in SAARC countries excluding India may need this even more, since there are very few large-sized companies in those countries, which limit investable opportunities. If the corporate sectors in those countries expand, it will lead to further scope for market activity in those countries.

Objective of this exercise: As this economic story unfolds, it should ideally translate into a financial story. This exercise discusses possible capital market Products/Activities regional stakeholders could explore to create closer interlinkage of SAARC’s capital markets, which could help realize the economic opportunity set to unfold in this region. Given the current state of maturity in the region’s markets, some ideas may be implementable now; while some may be implementable in the future as the markets mature further. However, the objective is to start deliberation on even the ideas of the future, since even that takes time. This exercise also looks at the economic projections of SAARC versus other regions (which is its main unique-selling point), their recent corporate performance, extrapolation of market indicators, and cases of integration in peer regions. Purpose of these ideas is to bring the region’s savings into local investments, instead of it moving overseas; evince retail and institutional interest through scope for diversification, yield, and risk mitigation; build product portfolios of the smaller markets; and reduce information opacity to ensure efficiencies in pricing.

Ideas include Conventional and Unconventional thinking: Conventional ones are typically used in integration, like funds, futures, global depository receipts (GDRs), cross-listings, passporting, etc. Unconventional ones try to convert SAARC’s unique challenges and opportunities into ideas for capital markets, i.e., how SAARC’s current state of demographics, socioeconomics, healthcare, investor, and knowledge maturity can become opportunities. Specific rationale are written with each idea why it makes sense for institutions and investors—be it large savings pool for funds, access to a diverse bouquet of sectors, access to multiple products to generate volume/assets, local brokers’ expertise in local stock coverage (especially in high-potential midcaps), access to a broader set of investors helping in valuation, liquidity, and low latency for cross-listings. Products also have to be viable. Hence, a clear focus is on how to deepen awareness of new products and new markets with local investors and institutions for products based on regional securities. Only when this happens, the asset flows should increase—thus, aiding viability.

Dual-currency conversion (to/from US$), double taxation of returns/dividends, sharing of brokerage among local and foreign intermediaries, and collection of market data from all the markets need to be addressed. Compliance with international accounting standards and dual-regulatory approvals gives comfort to investors in cross-border products. Separating the product structure at the country level can reduce the risk perception.

Any integrated product has to take into consideration the ground realities. Bringing an anchor partner can help counter implementation challenges in a geopolitically sensitive SAARC—from a country that has bilateral interests with SAARC members individually and is looking to earn returns from overseas investments. Such an anchor may also hold some sway with the SAARC members, which may enable disagreeable members to reach resolutions and agreement faster as they may not want to anger their larger bilateral partner. The anchor’s motivation would be the investment returns from SAARC’s opportunity and not really interfering in its internal affairs. That is easier said than done. But then, achieving consensus on SAARC projects from all its members has been the region’s challenge, and creating the economic motivation of investment returns to a strategic anchor may give them a reason to root for SAARC’s prosperity as a whole, without disrupting bilateral ties.

An initial push from an anchor may help garner interest from institutions that look at EMs and FMs separately. Evincing interest from long-term pension funds, superannuation funds, and sovereign wealth funds is a necessity as SAARC is a long-term story, and their buy-and-hold strategy can better realize the value created in this region in the long term. A SAARC asset class may hasten further country-specific funds based on South Asian FMs, as overall FM funds have only a small allocation to these FMs. As institutional interest picks up, retail interest should follow. It is an opportune time for retail, as one can leverage on online/mobile trading with adoption of smartphones.

For each product/activity, it discusses possible initial roles. Some work has been done to develop a harmonious framework. This would include financial disclosures and investor protection. One also needs to market the rationale of these initiatives to counter resistance, create awareness of the regional economies among the local investors, and engage with the industry to make them launch the products. Heterogeneous maturity of local markets restricts options, hence adoption of new products in the local markets is a precursor. The reverse may also occur, as integrated products may fuel the local demand. A role in financial engineering is also needed, since the structuring of integrated products by regional institutions is still in nascent stage. Financial engineering here refers to working on product structures, back-testing, and financial analysis. Hiring of specialized staff or consultants or identifying agencies to outsource these roles to is a precursor.

In a region which is unexplored as an asset class, performance will be the kingmaker. Hence, the project of creating a SAARC asset class basket is based on selecting the best performers, irrespective of the country of origin. While this may not give equal representation to all countries, the basket selects the best companies to deliver on performance. This, in itself, can be a measurement yardstick for companies to up their performance.

Smaller markets may fear losing business to liquid platforms overseas. But integration can broaden the access of local investors to a wider bouquet of products and new volumes that can offset the loss of migration of local business overseas. Integration can reduce the cost of capital for companies, leading to more capital-raising. The smaller players will never grow if they do not scale up, and integration can help in this.

In conclusion, it is an opportune time to look at SAARC. Recent years have seen new governments in the member countries, and most have stressed their commitment to deepen SAARC economic relations. This commitment, along with the economic potential set to unfold in this region, makes it a hot iron to strike now.

Chapter 2

Where SAARC Is Now

Products, Corporates, and Correlation

Abstract

This chapter looks at the products that are currently exist in the capital market of each of the individual member-countries that comprise the SAARC region, in order to estimate where the markets stand relative to each other in market maturity. It also looks at the performance of the Top-200 companies listed on the four main exchanges of the SAARC region—NSE India, KSE Pakistan, DSE Bangladesh, and CSE Sri Lanka, to assess where the listed companies of the region stack up against each other. The performance of Top-200 companies in SAARC ex India countries is actually improving relatively, apart from the low correlation to each other and global markets that reduces the risk of downside. It also shows the potential for the corporate sectors of the SAARC ex India markets to grow further is immense.

Keywords

SAARC; South Asia; India; Mumbai; Bangladesh; Dhaka; Sri Lanka; Colombo; Pakistan; Karachi; integration; corporate; stock; profit; revenue; margin; return on equity

Heterogeneous maturity of local markets is an opportunity to deepen adoption of new products: The table given below lists the products in the SAARC markets currently. Common products are few, which restricts the opportunities for integration now. But it spells opportunities to deepen the local markets with new products in the long term. Low market cap/GDP ratio indicates the scope to list more stocks, since market capitalization is less relative to its economic size. Low trading velocity indicates the scope to deepen equity participation, since trading volume is less relative to its market size. Most markets rank low on these ratios, offering headroom for growth in the cash equities segment.

Segments like futures and options (F&O), commodity, and currency are almost nonexistent outside India. Open-end mutual fund, a basic vehicle to mobilize retail savings into capital markets, is also quite rare. Close-end funds exist, but they cannot take subscriptions post the offer period, reducing the scope for mobilizing assets from future investors and for the asset management company (AMC) itself to reach a viable scale in its asset base. F&O comprise approximately 94% of India’s overall equities trading. While some F&O trading may be speculative, it also offers hedging and cash–future arbitrage opportunities, thus enabling risk management and price discovery.

Performance of Top-200 companies in SAARC ex India countries improving relatively: This is a key reason to look at the SAARC asset class. Performance of Top-200 companies in each of NSE India, KSE Pakistan, DSE Bangladesh, and CSE Sri Lanka (as per June 2015 MCap) shows that the Return on Equity (ROE) and Margins of top companies in Pakistan and Bangladesh were relatively better than India in recent years, while YoY topline growth in Sri Lanka was among the highest in 2014. Moreover, this was at much lower leverage than Indian companies, indicating they still have further room to raise capital if needed for expansion projects.

Bloomberg data as of June 2015 shows NSE India is the largest, as compared to KSE Pakistan, DSE Bangladesh, or CSE Sri Lanka (NSE Nepal, MSE Maldives, and RSE Bhutan are excluded as Bloomberg does not have coverage on them)...

Table of contents

• Cover image
• Title page
• Table of Contents
• Copyright
• Dedication
• Disclaimer
• About the Author
• Chapter 1. Introduction
• Chapter 2. Where SAARC Is Now: Products, Corporates, and Correlation
• Chapter 3. Where SAARC Can Reach: Showcasing its Main USP
• Chapter 4. General Precursors for Regional Financial Integration
• Chapter 5. Observations Specific to SAARC: Precursors to Consider
• Chapter 6. Potential Products and Activities
• Chapter 7. Recent Examples of Integration—ASEAN, MILA, Hong Kong–China, Singapore–China, and East Africa
• Chapter 8. Initial Role for Stakeholders: Regulations, Awareness, and Engineering
• Chapter 9. Conclusion
• Appendix
• Bibliography
• Index