Asians Must Rethink Their Investment Model - Fast

Source : The Business Times, December 6, 2007

By ANTHONY ROWLEY
IN TOKYO

A REMARKABLE fact to emerge at a conference this week was just how little confidence Asian investors appear to have in their own region, and how great their faith is in the US as a safe haven for investment. At this time of great (and growing) stress in the US financial system, it is worth asking whether this faith is dangerously misplaced and whether Asians ought not to be redirecting their savings elsewhere.

Only 5.7 per cent of Asian investment portfolios are invested in Asian assets, according to a paper presented by Brandeis University international finance professor Peter Petri during the Asian Development Bank Institute conference in Tokyo. This is a staggeringly small sum and one that calls for an explanation that goes beyond the relatively limited size of Asian stock and bond markets compared to those in other parts of the world.

Where do Asians put their savings? No less than 44 per cent of them flow to the US and a further 36 per cent to the EU while 13.5 per cent go to other 'advanced' markets. In other words, Asians put a full 94 per cent of their savings into what they fondly imagine are safe markets and just 6-7 per cent into what they see as more risky emerging markets including those of Asia. Contrast this with the fact that EU countries invest no less than 65 per cent of their savings in their own countries.

It is not as though Asia has such limited capacity to absorb portfolio investment. For example, US investors deploy nearly 20 per cent of their money in the markets of this region while Europeans invest 6.4 per cent and the world as a whole nearly 9 per cent. So, it is obvious that the rest of the world thinks that Asian portfolio investments are a good bet, even if that view is not shared by Asians themselves,

Asians sell themselves short by such attitudes, and they expose themselves to all kinds of risks (currency risk, commercial risk and even sovereign risk) investing so much of their savings in overseas markets. This is symptomatic of a lack of self-confidence; a feeling that, for all the 'Asian miracle' on the economic front, Asia has not yet been able to build a credible financial system worthy of investors' confidence.

It is, of course, true that things such as standards of accounting norms, financial disclosure and corporate governance leave something to be desired in parts of this region, and that official regulation of markets is often not all that it needs to be in some places. It is also true that Asian financial systems tend to be bank-dominated, leaving bond markets in a state of under-development and arguably over-emphasising equity markets.

But all of these things pale alongside the financial debacle that has occurred in the US in the wake of the sub-prime mortgage crisis. There, in the heartland of capitalism and in the midst of Anglo-Saxon presumptions of financial superiority, a disaster is unfolding that should send any right-minded Asian investor dashing for the exit just as quick as he can.

Financial systems that can create the kind of havoc in mortgage markets, credit markets, etc, which the sub-prime crisis has done in the United States are not worthy of confidence.

Perhaps, as Asia has felt little direct pain yet from the sub-prime crisis, investors here have been lulled into believing that the worst is over. It is not. Injections of official liquidity may stave off a complete seizing up of the financial system but this just means the pain will have to be taken over a long period of time. Slashing interest rates will prevent some financial failures but expecting it to prevent a US recession is as futile as pushing on a piece of string.

To come back to Asia, while people here may have been wise to avoid financial system development of the kind that spawned derivatives and other exotica which served to mask underlying risks in the Anglo-Saxon world, they seem very gullible when it comes to recognising risk elsewhere. Hence the huge outflows of portfolio investment capital from this region into 'mature' markets.

Some might say it is a mark of Asia's own maturity that the region is able to attract sufficient foreign capital inflows to finance its own investment needs. But this raises two points. First, most Asian countries have, by most analyses, been under-investing in new production capacity since the Asian financial crisis 10 years ago; and, second, relying heavily upon foreign investment capital has turned Asia into a kind of offshore production platform.

Economists might argue also that as most Asian countries run big surpluses on current account, they must have a compensating deficit on capital account. But what this means is that the export-led model of Asian economic post-war development has been overdone and that the region is at risk now of seeing a massive meltdown in the value of the foreign financial assets it has piled up by the sweat of its brow. Time to rethink the model - and soon.