Asia

Steven Beck

Asian Development Bank - Head of Trade and

Supply Chain Finance

Milan, 14th June 2018

• Thank you for the introduction, Dr. Boltho. Good afternoon ladies and gentlemen and thanks to UBI for inviting me to speak with this interesting group of people from so many countries. It’s important to organize these events to exchange views and ideas, which fosters partnerships and I commend and congratulate UBI for this initiative.

• I’ll begin my comments by confessing to being something of a fraud. I’m not actually an economist, as advertised, but will try my best to sound like one. For all my sins, I’m more of a banker. My view on Asia, naturally, is shaped by my experience in the region and the type of work I do.

• So before I try to demystify the region a bit and discuss in broad terms where I see opportunities and risk, and how best to navigate the region’s potential, I’ll take a minute to explain what the Asian Development Bank (ADB) is, as it is little known outside Asia, and can be of help in your efforts to expand in Asia.

Opening

• ADB is owned by 67 governments, including G7 countries, most western European countries, the People’s Republic of China (PRC), India, Australia, Uzbekistan, Afghanistan, Bhutan and Fiji, to mention a few. It’s a diverse mix of countries that own the bank and I’m guessing most, if not all of you, are shareholders in ADB as taxpayers, so thanks for that. Shareholders are divided between Member Countries – those would be developed countries like Italy, Japan, United States, Germany and Canada -- and Developing Member Countries of Operations such as Samoa, Mongolia and Georgia, Kazakhstan, the PRC, India and Bangladesh, to mention a few. All at very different stages of development, with different challenges and opportunities. The triple A rated ADB is headquartered in Manila, which in 1966, when the bank was established, was one of the most developed cities in Asia.

• The bank was created to reduce poverty in Asia. It does this by providing policy advice, technical assistance, loans, guarantees, equity investments. Until 15 years ago, ADB almost exclusively did large loans to governments for infrastructure projects and budgetary support. I think this is the reason that few have heard of ADB outside Asia; because there was no outreach, marketing, partnering or effort to do business with the private sector in Asia or elsewhere – the focus was entirely on working with government officials from ADB’s developing countries of operations. Unlike the World Bank, which broke its private sector off into a separate entity called the International Finance Corporation (IFC), ADB created a private sector department, which is where I work. So ADB’s private sector operations are only 15 years old.

ADB 1/2

• Today, we’re very focused on drawing in the private sector into our deals, into our developing countries, where we see lots of opportunity.

• I joined ADB 11 years ago to build the bank’s trade finance business. Our trade business operates in 21 countries, the 4 most active are Bangladesh, Pakistan, Sri Lanka and Viet Nam. Markets like India, the PRC, and Thailand are considered too developed for our trade business, so we have decided to focus resources on more challenging markets where the private sector has more trouble operating. Last year our business grew over 45% compared with 2016. In 2017, we provided guarantees or loans to over 3,500 trade finance transactions – mostly supporting SMEs – valued at $4.5 billion. First half of this year we continue to grow at over 45%. It has been difficult to keep up with the demand.

• We did a study to quantify market gaps for trade finance, which we estimate at $1.5 trillion on a global basis, over 40% of which is in Asia. Clearly there are serious opportunities for your businesses in Asia – our gaps study and our business volumes attest to that. We’ve never had a default in our trade business. Surely there is a good opportunity for your banks in the private sector to close more of this gap, and take some of this business from us, which, as I will discuss later, we would be pleased to help you do.

ADB 2/2

• Let’s take a look at these opportunities and the conditions that support them. Asia had a remarkable year, with growth accelerating throughout 2017 and into 2018. Asia has been the globe’s engine of growth. Sixty per cent of global growth in 2017 came from developing Asia. Asia is expected to grow by 6% in 2018, above the global average of 3.9%. This reflects solid export demand, both from the advanced economies, but also from within the region. Inflation remained moderate despite a 23% increase in oil prices during 2017.

• Beyond the numbers, for those of you who travel in Asia, you see the confidence, you feel the energy, the pace of physical, visible change; it is amazing. True, there has been cheap USD floating around for years and one thinks of bubbles and debt around so much growth, which we’ll discuss in a bit, the fundamentals are certainly more intact than pre-Asian financial crisis. I do not believe this is a flash in the pan.

Broad growth in Asia

• Let’s have a quick look at the two Asian giants, the PRC and India. I don’t want this entire discussion to be about the two giants, because there is much written about them. But no talk about Asia can be complete without discussing the giant Panda and Tiger in the room. And the scale is mind blowing. Combined, they represent almost 40% of the planet’s population.

Big Markets: The PRC and India

• I can confirm that the rebalancing of the PRC’s economy away from a dependence on exports to internal consumption is real. Domestic demand and the rising middle class is now a substantial factor, not only for the PRC’s economy, but for the regions’. It offers your clients incredible opportunities as it moves from “workshop of the world’ to a huge consumer market.

• Chinese household consumption rose from 13% of US levels to 34% in the past ten years. Forecasts are that the Chinese economy will expand by 42 per cent in the next 5 years. Chinese consumption is expected to reach 74% of US levels in less than 9 years. This will be an extremely important market.

• The Chinese, as well as other Asians, are quick to adopt technology. One can see the PRC’s economy now weaving the real and virtual worlds somewhat seamlessly, in many respects more advanced than what is taking place in the West.

• Naturally the PRC has challenges. It will need to tackle environmental challenges that come from rapid development, upgrade labor force skills, strengthen confidence in the enforcement of regulatory standards for food and other goods, and ensure a stable financial system. But based on the PRC’s past record of managing problems, including during the global financial crisis, the PRC is a good bet.

The PRC

• People like to bet on India over The PRC or vis versa. Which, in the long term can produce the best chance for prosperity? In my view it’s an interesting debate, but not mutually exclusive; both can win in their own way, by choosing their own path that works for their traditions and culture.

• In the next 5 years, the number of Indians joining the labor market will be 1.5 times the rest of Asia Pacific, the US and the EU combined. The question is, can India create enough jobs to absorb these staggering numbers. If so, it will fuel an incredible and sustainable period of growth. If not, this huge influx could create social and other tensions.

• The impact of artificial intelligence and automation on India’s ability to create jobs could be a concern. While the demographics and technologic changes are unstoppable, their impact can be muted or leveraged by policy. India has seen some interesting policy reforms of late.

• India is set to rebound from a dip in growth following reforms such as the demonetization of large banknotes in late 2016, which had lingering effect on small business and private credit. And reform that introduced a national goods and services tax temporarily slowed business activity early in fiscal 2017. New bankruptcy laws could have a major and positive impact on the Indian economy. So could the impact of a massive drive to biometrically provide ID to all Indians.

• Growth in fiscal 2017 was estimated at 6.6%, 0.5 percentage points below the previous year. Improved business regulation and buoyant tax revenue will bolster growth to the forecast horizon, as it accelerates to 7.3% in 2018 and 7.6% in 2019.

India

• But the exciting rise of Asia isn’t just about the two giants. I’d like to give you a flavor for what’s going on in the region outside India and the PRC in a sampling of countries that don’t get much attention in the western press, unless something goes wrong. Growth in Indonesia, population over 260 million, over the past 3 years was over 5% per annum. Growth in Bangladesh, population 167 million averaged 7%. Growth in Viet Nam, population 97 million and growing, averaged 6.6% each year over the past 3 years.

• Stopping on Viet Nam for a minute, it is one of ADB’s trade finance business’ biggest markets and what’s going on there is amazing – we can’t keep up with the demand for deals. FDI growth in 2017 was 47%. The largest investors are Korean, followed by Japanese, followed by Chinese. Investment ranged from electronics to garments and various parts and machinery. Training young people to support FDI in more technical fields is a challenge, but I’m confident they will tackle it. Viet Nam’s political situation is stable. The Vietnamese people are very practical people.

• Philippines, population over 100 million has been growing on average 6.7% for the past three years.

But not just about India and The PRC 1/2

• There is some healthy skepticism about emerging markets. At points there is exuberant enthusiasm and suddenly a crisis of some sort seems to set the country back a decade or more. But beyond the undeniable rise of the PRC, I truly believe we are witnessing in our lifetime a pivotal moment in world history where regional power is shifting to Asia, anchored to the PRC and India. The demographics and sustained growth rates support this view. And in my past 11 years working there I see a maturity and development of skills and know how that is difficult to see being reversed.

• Singapore’s rise from poverty to first world in one generation is an amazing story, but one can argue that it’s an outlier as a city state. Look at the amazing story of Korea, which went from one of the world’s poorest countries to one of the wealthiest in one generation. In 1960 it had a GDP per capital of $158, poorer, but comparable to Liberia in 1960 at $170, Cote D’Ivoir at $153. After decades of sustained growth rates, Korea today is the 11th largest economy in the world with a population of 50 million. Today, Korea’s GDP per capita has surpassed that of Italy and Spain’s at over $30,000 per year.

• We’re seeing similar year-on-year growth rates for Viet Nam, Indonesia, Bangladesh and other Asian countries, so the Singapore and Korea stories could be replicated in a number more Asian countries, very large countries. Your banks and your clients do not do not want to miss this historic opportunity by sitting on the sidelines.

But not just about India and The PRC 2/2

• An important dimension to the Asia story that many outside the region don’t fully appreciate is the strength and importance of intra-regional integration. Lots of people still believe the world revolves around Europe and North America and if those two continents aren’t doing well, no one does well. Yes, we are inter-connected and we’ve seen lots of examples of contagion. But Asia is increasingly less dependent on Western prosperity, as Asia itself becomes more prosperous. Part of the reason for this is the intra-Asian integration story.

• One element of this story is ASEAN, the Association of 10 Southeast Asian Nations (Thailand, Indonesia, Vietnam, Singapore, Malaysia, Philippines, Myanmar (Burma), Cambodia, Laos, Brunei). ASEAN, in some respects is an evolving EU-like initiative. The ASEAN initiatives, including its own economic community and the collaboration with the PRC, Japan, and South Korea under the ASEAN+3 framework is important. But I won’t touch on this as one of the other speakers will discuss.

• The One Belt One Road initiative is another element which is giving a push to intra-Asian integration, but I won’t touch on this either as another speaker will discuss later, except to say that ADB plays an important part in One Belt One Road which I’d be pleased to discuss during the panel discussion.

Intra-regional Dynamic 1/3

• Before I talk about intra-Asian trade, I’d like to touch on Japan for a moment – often forgotten by the West as a significant power and regional broker. The PRC may steal all the headlines when it comes to its infrastructure push across Southeast Asia and its One Belt initiative, but Japan is still well ahead in foreign direct investment in the region and an important element driving intra-regional cooperation. South Korea is also a major factor with manufacturing plants for electronics, the monster being Samsung, and cars spread around the region.

• As Japan’s population ages, the government and companies are searching for new markets overseas. Japan remains the dominant foreign investor in Southeast Asia. About 20 per cent of capital invested in the region the past seven years originated from Japan, up 6 percentage points from 2010. Don’t forget that Japan is still the world’s third largest economy. After an economy that overheated and suffered from decades of deflation, there are signs of inflation, following the central bank governor’s on-going aggressive measures such as monetary easing and historic low interest rates. (Incidentally, the governor of Japan’s central bank was ADB’s previous president.) Japan’s economy will likely grow 1.5 percent this year before slowing to 1.1 percent next year. Slow growth in wages poses a challenge to policymakers trying to inject further momentum into an economy now in its best run of expansion in 28 years. So in this context, and especially given the demographic situation, one can appreciate the importance for Japan wanting to be a part of the region’s huge growth trajectory.

Intra-regional Dynamic 2/3

• While Chinese FDI has some way to catch up to Japan in Southeast Asia, it is growing faster than Japan’s FDI, but only just. Because of rising labor costs in the PRC, companies are moving labor intensive assembly operations to Asian countries. One example is Cambodia’s large garment industry, where Chinese companies are major investors.

• Richer countries — including Thailand and Malaysia — show the highest rates of FDI from outside ASEAN; in Thailand, for example, over 50% of capital invested came from Japan and the US.

• Where is the money going? Nearly half of Chinese FDI invested in the region since 2003 was in resources. Intra-ASEAN FDI leaned heavily toward real estate: Thailand’s biggest property company Central Group, for example, is building Cambodia’s biggest shopping mall.

Intra-regional Dynamic 3/3

• Intra-regional trade is a big part of the region’s success and big part of why center of world economic gravity is shifting. Finding ways for your clients and, by extension, your bank to participate in an early stage of this intra-regional supply chain could represent a great opportunity.

• Trade within Asia grew by 13.1% in 2017, slightly outpacing 12.7% growth in Asia’s total trade, but not enough to significantly alter the share of intra-Asia trade in total trade, estimated at over 45% in 2017. When global trade growth slowed in 2016, Asia’s intraregional trade share rose to 57.3% above the 55.9% which was average during 2010-2015. This increase suggests the resilience of intra-regional trade linkage at a time when global trade was falling.

• Domestic demand in developing Asia will take the driver’s seat as private consumption and investment expand, triggering continued high growth in imports. The PRC accounts for about 20% of the value of all goods imported in the region, up from 5% in 2000, making it the region’s biggest and fastest-growing single source of imports.

Intra-regional Trade 1/2

• Tourism is another sector where the PRC’s growing importance to the region can be tracked — particularly in Thailand and Vietnam in which tourism is a significant contributor to GDP. Chinese tourist arrivals in Thailand accounted for 27% of the 33 million tourists who arrived in the kingdom in 2016.

• If you’d like to delve into the intra-regional trade story more, please refer to ADB’s publication, Asian Development Outlook (ADO) which you can google. Most of the information from this section come that that body of work that is published twice a year out of our Economic Research Department.

• I’d like to close this section by emphasizing that an important element to the exciting Asia story is its intra-regional component. The region is increasingly integrating and is increasingly less dependent on the West. It would be wise to strategize how to get involved in the intra-regional dynamic, perhaps through at the early stage of a value chain.

Intra-regional Trade 2/2

• Shifting to risks and looking at where this positive Asia story could get bumpy, we mustn’t completely discount some potentially bad outcomes from current strains between countries in trade. Increases in trade protectionism can impact consumer and producer optimism which would have ripple effects across Asia.

• Asia’s value-added exports shows that final demand in Asia accounts for 36.8% of its total value-added exports. This is increasing, however it means the region is still vulnerable to changes in demand from advanced economies, although it is somewhat buffered by the intra-Asian dynamic. Equally, the PRC is a regional hub for goods, but many of those head to the US.

• And let’s consider debt levels as another risk. In the PRC, for example, the corporate debt ratio rose from 96% of GDP at the end of 2008 to 163% at the end of the third quarter of 2017. In the same period, the household debt ratio rose from 50% to 67% in Malaysia, 74% to 94% in the Republic of Korea, and 45% to 68% in Thailand.

Risks 1/2

• Some people argue that private debt expansion is not necessarily a cause for concern, especially in emerging economies with immature financial systems. It may reflect simply the development of the national financial system from a low base.

• On the other hand, rapid debt accumulation can affect growth adversely. Financial vulnerabilities, which have built up during years of low interest rates, remain elevated, and could put growth at risk over the medium term. A faster-than-expected pickup in inflation or an escalation of protectionist trade measures could lead to a sudden tightening in financial conditions, which could, in turn, expose vulnerabilities in the financial system. Emerging market and low-income economies could face more capital outflows.

Risks 2/2

• Institutions, namely political institutions, are weak in developing countries and this leaves more room for instability, corruption, and generally poor governance. This characteristic of developing countries can pose a variety of risks.

• While the concept of good governance at all levels is still developing in much of Asia, standards are getting better. ADB and other multilaterals have been working with banks and governments in developing Asia to explain and insist on governance standards and transparency. There is real progress. I had a tough conversation with a Sri Lankan bank last month about governance and interrelated party loans to explain why we won’t deal with them and how they need to change before we do deal with them. I’ve had many conversations like this in Myanmar with banks 5 years ago; but they’re less frequent today. And a reasonable percentage of banks with which I had this kind of conversation a few years ago improved to the point where we’re working with them today.

Weak Institutions, But Strong Social Fabric 1/2

• Something a little more esoteric I’d like to explore with you, something that is difficult to explain to people who don’t live in or visit Asia regularly, is the sense of optimism prevalent in the region. And I would argue that while institutions in many developing countries of Asia are weak, the traditional fabric of society, its values, family, higher learning, respect for traditions, pride in culture, are very much intact and comfortably moving into the modern digital age. And perhaps this adds an element of stability that can’t be measured and that isn’t institutional per se. But I would argue that it’s a strength for Asia that should be factored somehow, regardless of how esoteric. It’s a foundation on which a healthy society striving to succeed needs to be based. Shared common values; national pride in development – perhaps the kind of sentiments that were prevalent when Europe and North America were developing.

• And to play with this concept just a little bit more, I think, perhaps, the divide between the 1% and the rest, the inequality – while striking in Asia and very problematic – perhaps has less of an edge because the middle class is growing so rapidly. People do see socio-economic mobility and believe the future is exciting and opportunities are available.

• Asians believe the future is theirs. There may be some more bumps in the road to becoming developed, but they’re confident it’s there and that confidence is critical to making development reality. Asia is a good bet.

Weak Institutions, But Strong Social Fabric 2/2

• I’d like to close by encouraging everyone to have an Asia strategy. The future, or at least much of it, is Asia: based on growth rates, population and the vast needs of massive rising middle class, this can’t be denied. It’s crazy not to have a long-term Asia strategy. By Asia strategy, I don’t necessarily mean something grand, encompassing all of Asia. And it needn’t involve huge upfront costs and risks. It can be something phased, incremental, gradual.

• Working with ADB, we could see how risks could be structured, mitigated, through the Trade Finance Program and or the Supply Chain Finance Program. We’ve been pleased to do a few deals in Pakistan with UBI. Beyond transactions, we’d be pleased to make introductions and furnish you with information to help you move into new markets in developing Asia.

• Only by being engaged in Asia, learning, establishing strong and transparent partnerships, can we be participants and beneficiaries of what is a historic shift toward Asia as the center, something not to be feared, but embraced.

Asia Strategy, ADB as Partner