Is ASEAN the next big growth play for global bond investors?

Published on Friday, 20 May 2016

Published by Donghyun Park on Friday, 20 May 2016

Customer counting Malaysian ringgit at a cafe.
Customer counting Malaysian ringgit at a cafe.

The dominant economic news of the year has been financial volatility in emerging and advanced markets alike. But one corner of the financial world—which could be the next big growth play—has received less attention: the 10 nations that comprise the Association of Southeast Asian Nations (ASEAN).

Since the beginning of the year, net foreign purchases of Indonesian, Malaysian and Thai bonds by foreign investors already reached $15.4 billion – $5.1 billion in Indonesian bonds, $5.6 billion in Malaysian bonds, and $4.7 billion in Thai bonds. This makes ASEAN one of the hottest emerging-market bond markets this year.

Interest in ASEAN markets seems to be driven by two major external and internal factors. The external driver is the continued abundance of global liquidity, notwithstanding the first interest rate hike by the US Fed in December 2015. The main internal driver is ASEAN’s strong medium- to long-term growth prospects.

The ongoing deceleration of economic growth in the People’s Republic of China (PRC) is encouraging global investors to look elsewhere for investment opportunities. For the first time in a quarter century, the PRC’s growth fell below 7% in 2015 to 6.9%, and is projected to decline further to 6.5% in 2016. While the PRC’s slowdown partly reflects a healthy, natural and welcome transition to a more balanced and sustainable growth paradigm, it is encouraging investors to take a closer look at other fast-growing markets. The PRC is no longer the only growth play in town for global investors.

The PRC’s slowing growth has made ASEAN more attractive to global investors. ASEAN countries have a collective population of around 625 million, or almost 9% of the world’s total, and a collective nominal GDP of more than $2.6 trillion in 2015. Furthermore, the region’s growth performance has been solid, although it has declined since the global financial crisis. ASEAN grew by 4.4% in 2015; its growth is projected to accelerate to 4.5 in 2016, and further to 4.8% in 2017.

Yet it is ASEAN’s relatively strong medium- and long-term growth prospects rather than the region’s short-run ups and downs that matter to investors. ASEAN’s rosy medium-term growth prospects are due largely to favorable structural factors, such as a relatively young population. Although the demographic transition toward older populations is already underway in Thailand and Viet Nam, overall the region is still young enough to reap the demographic dividend for some years to come.

The emergence of a single regional market under the ASEAN Economic Community (AEC) also makes the region more attractive as an investment destination. The AEC will help improve both trade and financial linkages across ASEAN markets.

Finally, some ASEAN countries will benefit from the PRC’s rapidly escalating labor costs and declining competitive advantage in labor-intensive activities. For example, Viet Nam has attracted foreign direct investment into labor-intensive manufacturing, and has become a leading producer of mobile phones and consumer electronics.

Notwithstanding the benign big picture, a number of risks loom on the horizon for ASEAN bond markets. Internally, political uncertainty—especially in Malaysia and Thailand—could play a role in the future, though up to this point markets appear to have priced in the political risk. On the external side, risks include a larger-than-expected and faster-than-expected rate hike by the US Fed, US dollar appreciation which harms corporate balance sheets, and a broader loss of investor confidence in emerging markets triggered by a crisis in a major emerging market with weak fundamentals like Brazil.

Be that as it may, the fact that the external vote of confidence in ASEAN bond markets seems to be driven by the region’s strong medium- and long-term growth prospects bodes well for their future beyond the short term.

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