Asia’s biggest emerging markets are flinging open their doors to court overseas investors, but there’s a catch — and it’s a big one. China, India and Malaysia have pledged to open up channels for foreign money to flow through their markets, with policy makers and heads of state publicly proclaiming their wish to be full-fledged members of the global financial system. But the reality often falls short of the rhetoric as national governments insist on maintaining regulatory systems designed to keep capital flows and trading rules under tight control.
Asia’s Tiger economies still remember how unfettered capital flows and free-market capitalism sunk their economies about 20 years ago. During the 1997-1998 Asian Financial Crisis, booming regional economies attracted ‘hot money’ capital from overseas and borrowed heavily in dollars. When currencies and stock markets cratered foreign investors headed for the exits, triggering a painful economic slump and banking crises.
That’s why Asian leaders, while welcoming foreign investors, are wary of adopting the Western-style liberalization template. “1998 is still on everyone’s minds,” said David Gaud, chief investment officer of Asia at Pictet Wealth Management in Singapore. “The Asia model will be a mix of Western rules and state strategy of opening up to help national development and not for total liberalization.”
The reluctance to cede control is creating tension with international investors and their governments, who are keen to profit from some of the world’s fastest-growing economies. “China and India are hard places to invest in,” said Devan Kaloo of Aberdeen Standard Investments in London. “They want to have control over domestic capital leaving.” But because the two countries are among the world’s largest and most attractive investment themes, money managers will take the trouble to access their markets, said Kaloo, global head of equities at Aberdeen, which manages $820 billion in assets.
The nascent opening comes during a testing period as a dollar rally and rising U.S. Treasury yields sucks capital from emerging markets. Asia hasn’t been immune, with heavy selling in Indonesia and others, including India, vulnerable to outflows. In emerging Asia, overall investor flows, including into stocks and bonds, are at the slowest pace since 2014, according to Bank of America Merrill Lynch.
Full access to Chinese financial markets is one of the simmering trade disputes between the U.S. and China. Meanwhile India, whose Prime Minister Narendra Modi spoke at Davos in January of “removing the red tape and laying out the red carpet” for business, has drawn criticism from index compiler MSCI Inc. for recent actions that curtailed offshore trading.
Days after Modi’s speech in Davos, exchanges in his country alarmed investors by taking the unprecedented step of axing overseas licensing deals on market data and derivatives products. And while India in April boosted the cap on foreign investment in its domestic bonds, its appetite for such inflows contrasts with China, which has steadily expanded access. Yet even in China, policy makers are only making it easier for overseas funds within strictly controlled systems.
Greater access to the world’s second-largest economy usually happens on closed loops such as the stock-trading links with Hong Kong, or restricted qualified foreign investor programs that require regulatory approval. Malaysia bans the dealing of its currency outside the country, and last year its central bank warned that trading futures contracts based on the ringgit on exchanges in Singapore goes against its policy.
Capitalism With Controls
“Asia’s markets are maturing and are simply not willing to follow someone else’s version of international standards,” said Joe Andrew, chairman of Washington-based law firm Dentons. “There’s a natural pride, or some may say arrogance, in managing the rules of opening up and this has led to contradicting forces battling each other.”
While some see it as pride, for Asia’s emerging nations there’s a strong political calculus. Modi and President Xi Jinping of China are both attempting deep-seated reforms of their economies and societies; placing their currency in the hands of unfettered free market forces risks jeopardizing their efforts. That’s one reason why China is reluctant to free up the yuan: Its move in 2015 to allow a modest devaluation sent shock waves through global investors, who feared a steep devaluation.
It’s a similar picture in Kuala Lumpur. While Prime Minister Najib Razak promises to let the markets decide the direction of the currency in onshore trading, officials are not letting up on a clampdown against speculators and international trading of the ringgit that began in the wake of the late-1990s crisis.
In 1997, the currency plunged 35 percent, reserves dwindled and the stock market lost half its value. Malaysia rejected a bailout from the International Monetary Fund and implemented capital controls. The move was initially met with vehement opposition, but the IMF and World Bank have since warmed to it.
Malaysia’s central bank has repeatedly reminded investors that its currency or related derivatives aren’t allowed to be traded offshore. “A currency is a reflection of a country’s sovereignty,” said Pictet’s Gaud, echoing the common theme among the nations.
China continues to enforce strict rules on moving money in and out of the country, restricting households and companies to transferring cash for reasons approved by the government. India also enforces its rules, and has a lengthy registration process to be a qualified foreign investor. It routinely intervenes to manage its currency, which is prone to volatility.
It may be that Asia’s countries have come up with a way to take part in global finance on their terms: Gateway hubs that offer a semblance of offshore independence while maintaining capital controls.
China’s stock-trading link with Hong Kong, which began in 2014, blazed a trail. The system lets investors in Hong Kong buy and sell mainland-listed shares without having an impact on the onshore yuan. The program was a key factor in MSCI upgrading China to emerging market status — all the Chinese companies that will be added to the benchmarks will be available through the link, meaning that foreigners won’t have to navigate capital controls or investment quotas, though the link has daily limits on net buying.
Directly or not, the link may have inspired others. India is promoting a tax-free financial hub in Modi’s home state as the country’s answer to international trading centers Singapore and Dubai. The Gujarat International Finance Tech City will be open to offshore investors with none of the usual hurdles. Meanwhile, Malaysia and Singapore are working on their own stock-trading link, which will allow investors in the city-state to trade without worrying about ringgit controls.
“It’s difficult to develop the market when regulators are reluctant to take on funding from foreigners,” said Johan Sulaeman, research director at the Center for Asset Management Research & Investments at the National University of Singapore. “Perhaps the trading links are somewhat of a compromise.”