Emerging Markets and Financial Resilience

Decoupling Growth from Turbulence

C. Hooy, R. Ali, R. Ghon, C. Hooy, R. Ali, R. Ghon, Kenneth A. Loparo, Kenneth A. Loparo

• Publisher: Palgrave Macmillan
• Year: 2013
• ISBN:
  9781137266613
• Topic: Business
• Subtopic: Corporate Finance
• Index: Business

Emerging Markets and Financial Resilience presents a picture of finance research. The issue of financial resilience in emerging markets is apt and timely as emerging countries are faced with the challenge of finding ways of sustaining their current trajectory in shaping the global financial architecture to ensure sustainable growth.

Part I

Introduction

1

Emerging Markets and Financial Resilience

Chee-Wooi Hooy, Ruhani Ali and S. Ghon Rhee

Research in financial markets which have special focus on emerging markets has gained momentum since the early 1990s. Today, the role of emerging countries in the world economy is significant. In the year 2010, more than 50 per cent of world output expansion at purchasing power parity (PPP) was contributed by emerging markets, the largest being China, 25 per cent, followed by India, 10 per cent, and Brazil, 4 per cent; and, given the uptrend of economic growth in these emerging markets, the figures are still rising.

Recently, we have seen a series of financial crises that originated from both developed and emerging markets. Unlike the emerging market crises that have little impact on the developed markets, the recent sub-prime mortgage crisis that originated from the developed markets (and the crisis’s aftermath, which is still ongoing) has affected their emerging counterparts. Malaysia, as one of the leading emerging markets, has no escape from these turbulences. Given the new financial landscape in the emerging markets over the last decade, there is a need to revisit and further explore existing theory and issues established on the basis of developed markets.

This book is a collection of papers that were presented at the 14th Malaysian Finance Association Annual Conference 2012, held at the Pearl of the Orient, Penang, Malaysia, over 1–3 June, with the conference theme: ‘Emerging Markets and Financial Resilience: Decoupling Growth from Turbulence’. This edited compilation adopts the same theme as the conference title. We collected 11 articles that shed light on the above issue.

The first section, ‘Financial Market Development and Business Cycle’, begins with the chapter entitled ‘Social Capital and Financial Market Development’ by Siong-Hook Law and Mansor Ibrahim. The chapter emphasizes the role of social capital in financial development. The authors first indicate that social capital does affect financial development, although the impact is weaker than that of formal institutions. Their further examination reveals that social capital and formal institutions are actually complementing each other in ensuring the development of the financial market. Nonetheless, the role of social capital becomes significant in facilitating the development of the financial market when the quality of the country’s formal institutions are low.

Tamat Sarmidi, Siong-Hook Law and Norlida Hanim Mohd Salleh further discuss the issue of financial development in the second chapter of this section: ‘Resource Curses Finance, Can Humans Stop It?’ The authors shed light on the relationship between natural resources and financial development by considering the human development channel. The chapter presents the notion that the relationship between resource abundance and financial development is non-monotonic, since many relationships between economic variables are not linear throughout time or space due to natural cycle of economic forces. Instead, human development contributes positively to financial development. The authors further suggest that the existence of a natural resource curse hypothesis in the finance–resource nexus depends on the level of resource dependency. Low–resource-dependent economies experience the positive contribution of natural resources to financial development, but this relationship is not applicable for high–resource-dependent economies. Interestingly, the study finds that too much reliance on natural resources could spoil the positive contribution of human capital to financial development.

This section ends with the chapter, ‘Forecasting Malaysian Business Cycle Movement’, by Shirly Wong, Shazali Abu Mansor, Chin-Hong Puah and Venus Liew. At the beginning of this chapter, the authors argue that early detection of a turning point in a business cycle is crucial, as information about the changing phases in business cycles enables policymakers and investors to cope better with unexpected events in the economy. In this chapter, empirical analysis has been conducted to evaluate the forecasting performance of the Malaysian composite leading indicator (CLI) in tracing the movement in the business cycle. Albeit the findings indicated that CLI is able to trace closely the business cycle and offer advanced detection of its turning points, it is evident that the lead times of CLI has been diminishing. This has significantly weaken the fundamental function of CLI as a leading indicator to signal economic vulnerability.

The subsequent section, ‘Regional Financial Market Integration’, begins with the chapter by Tze-Haw Chan and Ahmad Zubaidi Baharumshah, entitled, ‘Financial Integration between China and Asia-Pacific’. The chapter presents a joint investigation of the international parity conditions between China and its major trading partners in the Asia-Pacific over the globalization era. The authors claim that purchasing power parity (PPP) and real interest rate parity (RIP) are partially true among APEC-China. Both parities are time-varying and tend to hold better in the recent years, which is attributed not only to the financial liberalization process among APEC economies, but also to Chinese trade policy and the regional commitment for ASEAN+3+2+1 cooperation. However, China and APEC have improved their ability to absorb regional shocks, especially when the post-Asia crisis era is included.

The next chapter, ‘Budget Deficits and Current Account Balances’, by Ahmad Zubaidi Baharumshah, Siew-Voon Soon and Hamizun Ismail, examines the relevance of the twin deficits hypothesis and financial integration in 13 Asian countries. The chapter’s findings reveal that budget balance plays a significant role in the determination of a current account balance, and there is strong evidence supporting the Keynesian view of the twin deficits. Next, investment has a notable impact on current account balance and is in line with the theoretical prediction. Lastly, the authors point out that the Feldstein–Horioka puzzle seems to be valid in most of the countries, even after allowing for a break in the data. This chapter suggests that financial integration remains weak in most of the Asian countries, as is evident from the degree of international capital mobility and that certain of the economies (China and India) appear to be effectively closed.

The last chapter of this section, ‘Asia-Pacific Currency Excess Returns’, by Yuen-Meng Wong, focuses on the potential profits opportunity by exploiting the failure of the forward unbiasedness hypothesis in the Asia-Pacific foreign exchange markets. The chapter shows that the forward bias puzzle is not a severe problem in most of the Asia-Pacific foreign exchange markets. Nevertheless, the failure to reject the forward unbiasedness hypothesis in the Asia-Pacific foreign exchange markets is predominantly due to the huge standard error of estimates. However, domestic stock markets’ excess returns are shown as the main driving force to the currency excess returns from the Asia-Pacific foreign exchange markets. Instead, the common risk factors such as the U.S. stock market excess returns and the U.S. inflation rate have little impact in explaining the excess returns of the Asia-Pacific currency markets. Last, but not least, Wong finds a general absence of calendar effect in the Asia-Pacific currency excess returns.

The third section, ‘Foreign Direct Investments and Equity Investments’, begins with the chapter by Catherine Ho, Khairunnisa Amir, Linda Nasaruddin Sia and Nurain Farahana Zainal Abidin: ‘Openness, Market Size and Foreign Direct Investments’. This chapter tends to determine the significant relation between trade openness, market size and foreign direct investment (FDI) in fast-emerging countries, including Brazil, Russia, India, China, South Africa (given the acronym BRICS) and Malaysia. The authors innovatively investigate a new factor, index of economic freedom from the Heritage Foundation, in the analysis on FDI. The authors indicate that market size, interest rate and infrastructure quality are the critical factors in determining FDI inflows for this group of emerging countries. In this chapter, the authors suggest that empirical findings should provide authorities in emerging countries with policy recommendations to further accelerate development through foreign investments.

The next chapter, by Shangkari V.Anusakumar, Ruhani Ali and Chee-Wooi Hooy, is titled ‘Momentum and Contrarian Strategies on ASEAN Markets’. This chapter emphasizes the profitability of momentum and contrarian strategies in four emerging ASEAN stock markets. The authors demonstrate that there is no momentum in Malaysia and Thailand, although negative momentum is found in the Philippines and Indonesia. Long-term contrarian strategy is highly profitable in the ASEAN markets but only marginally significant in Malaysia. The authors further indicate that the highest returns were found for ranking and holding periods of not more than 48 months. Moreover, the findings are generally unaffected by the January seasonality and the global financial crisis. Nevertheless, survivorship bias seems to influence momentum and contrarian returns, particularly for the Malaysian market. In sum, the authors give us the notion that investors would be able to generate significant profit by implementing a contrarian strategy in the ASEAN stock market.

This section ends with ‘Socially Responsible Investing Funds in Asia-Pacific’, by Wei-Rong Ang and Hooi Hooi Lean, who shed light on socially responsible investing (SRI) funds which are growing rapidly throughout the world. Statistics from the European Sustainable Investment Forum (Eurosif) 2010 report showed that 0.82 per cent of the total SRI assets are from the Asia-Pacific region. The Asia-Pacific region is still in the process of developing this alternative investment instrument. This chapter attempts to analyze the performance of SRI funds that were invested in the Asia-Pacific region from January 2003 to June 2010. Ang and Lean employ the standard reward-to-volatility ratios, that is, the Sharpe ratio, Treynor ratio and Jensen’s alpha as well as the Fama-French model and Carhart model for the analysis. A positive monthly return of 0.26 per cent on average is found, which is better than the U.S. T-bill. This infers that SRI funds are still profitable, although they are restricted from investing in certain sectors. Consistent with previous literature, Ang and Lean find no significant difference in the performance of SRI funds against the conventional benchmarks. Moreover, SRI funds are conservative funds with respect to the markets. There is no small size effect but growth effect and momentum effect are found in the funds. Hence, this chapter suggests that SRI funds can be developed as an attractive alternative investment instrument in the Asia-Pacific region.

The final section, ‘Issues in Corporate Finance and Banking’, begins with the chapter by Razali Haron, Khairunisah Ibrahim, Fauzias Mat Nor and Izani Ibrahim: ‘Capital Structure of Southeast Asian Firms’. The authors argue that inconclusive results in capital structure studies are still unresolved to date. Various possibilities and justifications are being put forward by researchers past and present to rationalize their inconsistent findings. Different leverage definitions used in the studies are identified as being among the main factors that lead to inconsistent results recorded in the literature. Different leverage definitions serve differently according to the needs of the study and this leads to inconclusive findings. Different models employed also played a significant role in this issue of inconsistencies. Different natures of models employed greatly influence the results in capital structure studies throughout. This chapter proves that inconsistent results reported within Malaysia, Thailand and Singapore are due to the different definitions of leverage (six leverage measures used) as well as the different models (the static and dynamic models) employed. Inconsistencies are more rampant in the use of different leverage definitions with the same model as compared to different models with the same leverage definition. The Fixed Effect Model and Partial Adjustment Model are employed representing the static and dynamic models respectively. Therefore, the capital structure studies still need one universally accepted leverage definition and also one appropriate model to satisfy the needs of in-depth understanding of the relationship between capital structure decisions and the value of a firm.

The last chapter in this section, ‘Determinants of Bank Profits and Net Interest Margins’, by Rubi Ahmad and Bolaji Tunde Matemilola, focuses on the investigation of the determinants of bank profits in the post–Asian crisis era, using panel regression analysis. The findings indicate that capital adequacy, management efficiency, credit quality, GDP growth, inflation and concentration ratio are important determinants of bank profits. Conversely, size, liquidity, capital adequacy and management efficiency are important determinants of the net interest margin. In sum, the authors conclude that bank-unique factors such as capital adequacy and management efficiency are consistent determinants of bank profits and net interest margins.

Over the last turbulent decade, policy makers and regulators in emerging markets have taken many measures to improve their economic systems, especially on the depth, efficiency and transparency of their financial markets. Their aim is to allow investors, both local and foreign, to make more informed choices. However, like the body of a human being, the financial sector cannot be strengthened overnight. With a high degree of globalization, the world financial market today is extremely integrated and interrelated. Thus, we need to know and understand the common threats to emerging markets. This is to ensure that a collective prudent system can be built in the near future to withstand stiff challenges ahead. Furthermore, emerging markets are by nature more vulnerable to economic and financial crises. It is unwise and unrealistic to think or assume that the policy framework from the Western developed markets can be easily installed to avert turbulence. We hope that what this book has put in place can offer the parties concerned – especially policy makers, regulators and investors – a bigger picture of what emerging markets should pay attention to during their further development and evolution. This would aid in establishing a more resilient financial sector to decouple its economic growth from the turbulence ahead.

Part II

Financial Market Development and Business Cycle

2

Social Capital and Financial Market Development

Siong-Hook Law and Mansor Ibrahim

1 Introduction

In the 1990s, institutions became an important area of focus when investigating the process of financial development and the success or failure of financial reforms. This was partly a consequence of the failure of many developing countries that had liberalized their financial systems to realize the expected benefits from such reforms. For example, Demetriades and Andrianova (2004) argue that the strength of institutions, such as financial regulation and the rule of law, may determine the success or failure of financial reforms. Chinn and Ito (2006) also suggest that financial systems with a higher degree of legal/institutional development tend to benefit more from financial liberalization than do those with a lower degree. Mishkin (2009) points out that a legal system that enforces contracts quickly and fairly is a prerequisite for supporting strong property rights and financial development. Thus, eliminating corruption is essential to strengthening property rights and the legal system, which will further enhance the healthy functioning of economic and financial systems.

Another recent strand of the literature has focused on the relationship between informal institutions (or ‘social capital’) and financial development. Social capital is often defined as shared norms that promote cooperation between two or more individuals (Coleman, 1988; Fukuyama, 1999; Ostrom, 2000).¹ Shared norms facilitate the functioning of a society by fostering trust and reducing the incentive to cheat. At the same time, people in the society may rely more on others keeping their promises due to the moral attitude imprinted upon individuals through education. Trust increases people’s perception that others will cooperate. Thus, trust can play an important role in supporting cooperation in large organizations, such as the government and large firms (La Porta et al., 1997), or simply in large markets. Numerous studies have been conducted to analyse the role of trust-based social capital and economic performance. Among others, Knack and Keefer (1997), Beugelsdijk and Schaik (2005), Dinda (2008), and Dearmon and Grier (2009) have found a positive association between the level of trust and economic growth. Nevertheless, empirical evidence on the influence of social capital on financial market development remains relatively thin. To our ...

Table of contents

• Cover
• Title Page
• Part I Introduction
• Part II Financial Market Development and Business Cycle
• Part III Regional Financial Market Integration
• Part IV Foreign Direct Investments and Equity Investments
• Part V Corporate Finance and Banking
• Index