M4: A new capital highway?

Vietnam’s economy is riding high – again. After several years of middling performance, gross domestic product expanded by 6.7% in 2015, the fastest annual rate of growth since 2007. Analysts hope this is just the start of a new period of relative outperformance by the frontier market. In a February 22 report, HSBC Global Research tipped the economy to expand by 6.7% in 2016 and 6.8% in 2017, boosting per-capita income to US$2,400, a rise of 140% in a decade. Investors are keen to tap into Asia’s fastest growing major economy after India (which expanded by 7.3% in 2015) and China (which, despite homegrown woes, grew by 6.8%). Indeed, positive data is evident wherever you look. In its February note HSBC projected inflation, which fell to zero in the final quarter of 2015, to average 2.9% in 2016, boosted by higher food costs. Final consumption growth is currently running at around 9% a year, driven by a robust real estate market and high automobile sales. New car purchases hit an all-time high of 23,775 in December 2015, up more than 35% year-on-year, according to data from the Vietnam Automobile Manufacturers Association. The domestic banking sector, once clogged with soured or failing assets, has been cleaned up: non-performing loans fell to 2% in 2015, from 17% at their peak in September 2012. All of which is catnip to global money managers. “Investment in a good company in Vietnam is not necessarily a good investment for a foreign investor if one is constrained by access to capital markets and liquidity. We hope to see a successful dual listing of Vietnamese companies in more established regional exchanges, such as the SGX.” “A new institutional investor comes to talk to us about Vietnam every two weeks,” said Lien Le Hong, regional head of institutional research at Maybank. “About half are from Asia, with the remainder split evenly between the US and the UK.” Adrian Pop, a Hong Kong based portfolio manager at East Capital, an emerging market investment manager with €2.1bn (US$2.34bn) in assets under management, says he is “constantly increasingly exposure” to local assets. “Vietnam came second in 2015 in terms of outperforming the benchmark in our Emerging Asia fund. The market was up 6% last year in local currency terms and 1% in dollar terms. That outperformed every market we invest in, with the exception of China’s A-share market. Things are falling into place nicely.” The core values that have long attracted investors, including a high level of political stability and a large, ambitious, and consumption-driven populace, remain firmly entrenched. “Vietnam has very appealing demographics from an investment perspective,” said Jonathan Bowden, a partner at law firm White & Case in Singapore. “A rapidly expanding middle class is driving domestic demand and providing a low-cost workforce, attracting the interest of potential foreign investors.” The government has mandated five European lenders – BNP Paribas, Credit Suisse, Deutsche Bank, HSBC and Standard Chartered – to sell its story to fixed-income investors, and a US dollar sovereign bond is on the cards. Yet this is also a market still very much in its infancy, where good and bad news often commingles. Investors are of course attracted to a fast-growing market where valuations still lag top-line growth. Vietnam’s VN Index was priced at 1.68 times net assets at end-February 2016, close to a three-year low. “It’s not like the market is extremely highly valued,” said East Capital’s Pop. “It’s currently trading at around 13 times forward earnings for 2016 and 11 times 2017 forward earnings.” Private equity majors are pushing in hard, in search of underpriced assets. A consortium led by Warburg Pincus ploughed US$100m in Vincom Retail in March 2016, taking its total investment in the domestic shopping mall operator to US$300m. East Capital’s Pop sees hidden value in sectors including retail, IT and cement. White & Case’s Bowden said hot sectors were those that tapped i

Malaysia has been the driving force behind the development of an Islamic capital market in Asia. As much as 25% of all financing assets in the country’s banking system are now sharia-compliant, according to a 2015 review from consultancy EY, with 21% of total banking assets qualifying as Islamic. A common determination on the part of the government, finance ministry and central bank has fostered the creation of a deep pool of long-term Islamic capital, in turn driving local demand for long-term assets such as infrastructure financing. The local ringgit market has weathered a political storm in recent months, and recent issues in the global markets show that Malaysia has also broadened its links with international Islamic investors, especially in the Middle East. Infrastructure-related trades, principally related to road construction, are heavily represented in the Malaysian pipeline. CIMB forecast last December that as much as M$75bn (US$19.3bn) of new Malaysian sukuk could print in 2016. Around M$34bn of Malaysian corporate sukuk is maturing this year, offering the possibility of a round of refinancing trades. “Notwithstanding the uncertainties surrounding the general market outlook, we expect Malaysian sukuk issuance to sustain its momentum and to exceed last year’s tally in 2016 for a total of approximately M$65bn-$70bn in 2016.” “Islamic finance is no longer a fad,” said Ashraf Mohammed, ADB’s assistant general counsel and Islamic finance practice leader. “The Islamic market can be a stable alternative because of its linkage with real assets.” Efforts to connect sharia-compliant investors with infrastructure projects elsewhere, however, have proven more challenging. And even in Malaysia, growth is slowing. EY recorded a modest 0.6% market share gain for Islamic finance versus conventional banking in 2014, well below the 1.2% median for the previous four years. This points to a maturing market that will need to innovate if it is to continue to expand. “Islamic issuance from Malaysia slowed last year due to a combination of domestic economic weakness, the slowdown in China, a slumping oil price and uncertainty with regard to Federal Reserve rate tightening,” said Effendi Abdullah, head of Islamic markets at AmInvestment Bank in Kuala Lumpur. Challenges Sharia-compliant issuance has been the mainstay of ringgit bond markets over the past decade, but issuance has declined in the face of the deteriorating credit outlook and weak onshore liquidity. According to data from Thomson Reuters, US$40bn-equivalent has been issued in conventional ringgit bonds over the past decade, versus US$130bn-equivalent issued in sharia-compliant paper. The primary market has been on a downward trend: from a mammoth US$23bn-equivalent issued in 2011, issuance tailed off to US$13.8bn-equivalent last year. So far in 2016 US$1.9bn has been sold. Barring a forthcoming pick-up, this pace would take back the primary Islamic ringgit market to its paltry issuance of early in the last decade, when the average annual tally was US$7bn-equivalent. Dragging down ringgit issuance in sukuk last year was the refusal of central bank Bank Negara Malaysia to issue short-term sukuk paper with less than three months’ maturity, citing the poor transmission of short-term sharia issuance to domestic liquidity. Most of the paper BNM had issued in the previous few years was used by offshore central banks to manage their short-term liquidity. BNM’s withdrawal from short-tenor sukuk caused overall sharia issuance to contract by around US$10bn-equivalent last year, according to Standard & Poor’s. Still, the theory was that the corporate and government-linked sector would fill in the gap left by BNM’s retreat. Credence was given to this view at the end of last year, when Malaysian corporates and state-owned enterprises rushed deals into the market, which in December raised a combined M$3.9bn in sukuk. But a US dollar issue from state pension fund Khazanah in February again l

Heavy fines for breaches of money laundering regulations are making global banks reluctant to venture into Asia’s frontier markets, even through the traditionally low-risk area of trade finance. That “de-risking” phenomenon is contributing to a global trade finance gap that the ADB estimated at US$1.4trn in its most recent survey, with almost half of the shortfall in developing Asia. The bank’s October 2015 annual survey, based on responses from 253 banks in 86 countries and covering transactions in 2014, found that 45% of lenders had terminated banking relationships because of compliance requirements. In over 25% of those cases, banks reported they had no suspicion or evidence of non-compliance – a sign that compliance is crimping legitimate business transactions. “It’s a challenge for the industry. The big international banks look at AML fines when they measure the risk of taking on new partners in countries such as Myanmar. It’s one of the reasons why they are pulling out.” Almost 80% of banks cited anti-money laundering and know-your-customer requirements as an impediment to trade financing, and 93% said they expected compliance measures to increase. “It’s a challenge for the industry,” said Steve Beck, head of the ADB’s trade finance programme. “The big international banks look at AML fines when they measure the risk of taking on new partners in countries such as Myanmar. It’s one of the reasons why they are pulling out.” Consultants at Greenwich Associates rank HSBC as the market-share leader for large corporate trade finance across Asia, ahead of Standard Chartered. HSBC reached a US$1.92bn settlement with US regulators in 2012 over charges tied to money laundering and breaches of sanctions in markets including Myanmar. The bank has since spent over US$680m and added 2,584 compliance staff, US prosecutors said in April, citing an independent monitor. Standard Chartered paid US$667m in 2012 after breaking sanctions, including in Myanmar, and was fined another US$300m in 2014. The ADB added the first Myanmar institution to its trade finance programme last year, welcoming Cooperative Bank, a privately owned lender with 149 branches across the country. The multilateral has yet to complete its first deal with the bank, but is already looking to bring other Myanmar institutions through its due diligence programme. Through the trade finance programme, the ADB supports around 2,000 transactions a year by standing behind banks in the region’s frontier markets. It provides revolving credit facilities directly to banks and guarantees payments from emerging lenders to global partners, especially commercial banks. It is most active in Vietnam, Bangladesh, Pakistan and Sri Lanka. Last year’s support declined from US$3.8bn in 2014 to around US$2.5bn when measured by the dollar value at risk. That, however, was a result of lower commodity prices rather than a reduction in the bank’s activity or lower demand for its services. “We think there is a gap and there is a clear impact on jobs and trade volumes,” said Beck, noting that the number of transactions the ADB supported had remained relatively constant. Beck expects a similar outcome in 2016, given that the outlook for commodities remains depressed. “Trade is slowing, and it’s a really tough environment,” he said. The ADB added two more partner banks in Vietnam in 2015 and has increased its presence in Bangladesh with three new partner institutions joining in March 2016. Similar agreements in the Pacific region are expected shortly. Capital pressures It is also set to introduce a new product to support global financial institutions struggling with their own regulatory capital requirements. The funded risk participation agreement is designed to qualify as a “true sale” distribution for global banks, allowing big international partners to continue to support trade without setting aside capital. Beck sees “significant demand” for the new product. “We want to work with international banks

A geothermal power project in the Philippines has raised hopes that Asia’s capital markets can play a bigger role in financing sustainable infrastructure projects. Aboitiz Power issued Asia-Pacific’s first climate bonds in March to refinance its Tiwi-MakBan plant, after obtaining Ps12.5bn (US$263.4m) in credit facilities and guarantees. The deal stands out as a rare capital markets financing for an infrastructure project in Asia, where companies have traditionally relied on bank lending to fund long-term developments. The key to maximizing the impact of the deal, however, will be replicating the structure for other infrastructure assets across the region. The facilities comprise climate bonds of Ps10.7bn, to be backed with a guarantee from ADB, and a direct ADB loan of Ps1.8bn. Under the guarantee, ADB will provide credit enhancement for 75% of principal and interest on the bonds, with the support of Credit Guarantee & Investment Facility. Bank of the Philippine Islands was the sole lead manager and bookrunner on the bonds. “Credit-enhanced project bonds offer an attractive alternative to bank financing and, by mobilizing cost-effective, long-term capital, can help close the region’s infrastructure gap,” said Todd Freeland, director general of ADB’s private sector operations department. The operator of the power plant is AP Renewables (APRI), which will also be the issuer of the bonds. Proceeds from the issue will be used partially to redeem APRI’s redeemable preferred shares and partially to fund the operating expenditure and future rehabilitation needs of the power plant. While the ADB would like to reproduce the format elsewhere, insiders acknowledge that the use of proceeds is a challenge for a multilateral development bank. The ADB and its peers prefer to focus their finite financial resources on greenfield projects, where they can demonstrate the biggest development impact. Refinancings are rare and multilaterals often shy away from deals that allow the project sponsor to take out a dividend – as was the case for Aboitiz. Bond markets, meanwhile, have yet to develop an appetite for greenfield project risk. Institutional investors prefer to see evidence of stable cashflows, a solid offtake contract and predictable production or generation capacity. Geothermal projects require a significant amount of upfront costs, and steam generation can drop off quickly, adding to the risk for lenders. In the case of Tiwi MakBan, however, Aboitiz had invested its own equity to rehabilitate and upgrade an existing asset with a proven generation history and the ADB’s credit enhancement helped it normalise the project’s capital structure. “There are now some precedents for project bonds, and we have seen great interest from commercial banks,” said Christopher Thieme, director for infrastructure finance in the ADB’s private sector department. “Increasingly local currency solutions are becoming available as local sophistication is growing.” The Tiwi-MakBan power complex was acquired from the state-run National Power Corp in 2009. ADB has been involved in the project since August 2014, when Aboitiz started looking to refinance its equity investments. ADB’s guarantee will be made in conjunction with CGIF, which will mark its first involvement in a project bond. Geothermal assets are attracting interest from global sponsors with the sale of US oil major Chevron’s Asian portfolio, valued at an estimated US$3bn. Equity analysts have also welcomed the additional source of financing. Shares in US-listed Ormat Technologies, which made the generators for the Tiwi plant, are up 14% this year. JP Morgan said the company stood to benefit from the issuance of credit-enhanced Green bonds, “a source of finance that could support development of geothermal energy resources in developing nations”. This is the first Asian bond offering to be certified by the Climate Bonds Initiative, a UK-based NGO that promotes green finance. The ADB says these are also t

In Paris last December, 195 countries agreed on a landmark global plan to tackle climate change by keeping the average increase in global temperature to below 2 degrees Celsius. The pledges from the United Nations Climate Conference, known as COP21, require all signatories to outline their own specific plans to address emissions and report regularly on their progress. Developed nations will make at least US$100bn of climate financing available each year from 2020. The world’s first legally binding climate contract came shortly after world leaders agreed to work towards 17 sustainable development goals (SDGs) at the UN Sustainable Development Summit in September. “Last year was an important year for the global development community because of the COP21 and the SDGs,” said ADB President Takehiko Nakao. “Asian countries have made a commitment to reduce emissions under the COP, and we should support this.” “Capital market financing needs – combined with rising demand for socially responsible investments, standardization of offerings and the issuance of benchmark-sized deals that are effectively priced – should increase green bond issuances for years to come.” Indeed, the first country to submit its nationally determined contribution plan was Papua New Guinea, also one of the ADB’s members. The Paris framework was due to be ratified in New York on April 22. High-level agreements, however, are no guarantee of action. Given the scale of investment required, Asia’s ability to finance climate-sensitive projects will need the full support of both the public and private sector. That will be far from straightforward. Asia lacks the dedicated green and responsible investment funds that are growing fast in Europe and the US, and many of the region’s governments have a history of taking the lowest-cost infrastructure option over the most environmentally sensitive one. While previous rounds of climate talks have led to criticism that developing nations are not doing their bit, Nakao believes that attitude has changed. Even with coal and oil prices near multi-year lows, he sees a strong commitment to action. “Asian countries are so keen on this issue, because they are so susceptible to climate change,” he said. “It’s also related to pollution.” China, Asia’s biggest source of carbon emissions, has made climate action a key part of its latest five-year plan, agreed at the National People’s Congress in March. The development of a green financial system is a central tenet of that initiative, with efforts already underway to promote Green bonds, a green rating system, stock index and carbon trading. China’s central bank is co-chairing a green finance study group with the Bank of England, seen as a focus area of its G20 presidency. As an example of China’s commitment, Nakao cites a US$300m ADB loan to support anti-pollution activities in the Beijing-Tianjin-Hebei area – China’s first policy-based loan from the development bank. India has also pledged to expand solar energy capacity to 100 gigawatts under Prime Minister Narendra Modi, who has made renewable energy a focus for his government. The first big project, however, is up in the air after US solar giant SunEdison, which won the tender for a 500MW solar plant last year, lurched towards bankruptcy protection in April. Private financing can be a problem, especially in early-stage technologies, but project finance specialists believe the funding gap is narrowing, easing pressure on public sector support. “These technologies are expensive, clunky and subject to significant improvements year-on-year, but if nobody invests in the first-generation technology then the R&D process grinds to a halt,” said Christopher Thieme, director for infrastructure finance in the ADB’s private sector department. “Recent solar projects, however, have been almost at parity with the cost of fossil fuels – at least before the oil price crash.” Greener markets Recent financings point to some encouraging progress in t

A landmark issue in Thailand’s local bond market last year has underlined the challenges in the integration of South-East Asia’s capital markets. Japan’s Mizuho Bank sold Bt3bn (US$85m) of three-year 2.33% bonds in September, completing the first under the ASEAN+3 multi-currency bond issuance framework (AMBIF). Siam Commercial Bank was sole lead manager for the offering. The notes were placed in Thailand and also listed on the Tokyo Pro-Bond market. Mizuho’s long-awaited debut came weeks after regulatory agencies in Malaysia, Singapore and Thailand implemented the framework for the ASEAN common prospectus, which essentially provides for borrowers to file only one standard set of documents to sell debt in the three markets. The deal, however, met a cautious response from investors and remains the sole issue under the AMBIF template. “We learned several lessons from the first Thai baht issue,” said Tomo Yamadera, principal financial sector specialist at the ADB and head of the Asian Bond Market Forum, an ASEAN+3 initiative. “What we try to do is introduce international market practice into the domestic market, and sometimes through a lack of experience people resist – even though regulators may be pushing this initiative.” The AMBIF concept has had a long and slow gestation since it was first proposed by ASEAN ministers in 2012, and Thailand raised further questions for potential cross-border financings during the global market sell-off earlier this year, with a restriction that any proceeds must be used “in baht in Thailand”. Yamadera does not see that as a hurdle to future AMBIF issues, since the framework is mainly intended for ASEAN companies who want to increase their local funding for their foreign subsidiaries. “ASEAN currencies depreciated against the US dollar last year but within ASEAN it was relatively stable. Many companies who used to manage their treasury in US dollars are now wondering how they can manage their growing exposures in the region,” he said. Regulators elsewhere have expressed their strong support for the format, notably in the Philippines and Malaysia, but even with policymakers on board deals have yet to materialize. “It is importance to raise awareness in the market,” said Yamadera. “Unfortunately market turbulence over the last year has made people cautious to look at new deals, but once the market has stablised we are very much hoping that we can create another deal.” To view all special report articles please click here and to see the digital version of this report please click here. To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com.

The Association of Southeast Asian Nations has long been a slow-burn project. For decades the organisation, which comprises 10 member states from tiny Brunei to sprawling Indonesia, has promised much while consistently underperforming. As an economic and financial entity, ASEAN has managed to be less than the sum of its parts. Yet, could this be about to change? Are the varied and vibrant economies of South-East Asia finally set to realise their vast collective potential by learning to work in harmony with one another – to embrace economic integration in the name of greater regional trade, while expunging their protectionist tendencies? The region’s supporters – and there are many – believe so. When the ASEAN Economic Community took effect on the last day of 2015 after years of delay, its purpose was clear, its chief goals ambitious. Using the AEC’s legal framework, regional political leaders would set out to liberalise the flow of goods, services, capital and workers, and improve infrastructure. In time, the hope was to transform South-East Asia into a single market and production base, with the aim of rivalling and even replacing China as the workshop of the world. Ambitious? Certainly. Achievable? Just possibly – but only if everyone buys into the project and sticks by the same rules. This is after all a region where neighbourly trust often seems in short supply. So whether the new economic community is achievable in reality, rather than just looking pretty on paper, remains to be seen. “Almost every regional nation state is guilty of protecting its own industries and resources at the expense of greater regional trade. All this did was to undermine their own competitiveness.” On one issue everyone can agree: the region’s enormous, manifold promise. Were ASEAN a collected entity, its economy would be valued at north of US$2.5trn, making it the world’s sixth largest after the United Kingdom. If current trends prevail, the region’s powerhouse-in-the-making, Indonesia, is set to become the world’s fourth largest economy by 2050, after India, China and the United States, according to the US Census Bureau. South-East Asia is both populous and young. It is home to more people (630 million) than the United States (320 million) or the European Union (510 million) and has the world’s third largest labour force after China and India. It boasts multinationals fully embedded in global supply chains, and deep reserves of every conceivable commodity, soft and hard. In 2014, ASEAN absorbed US$138bn in inward foreign direct investment, according to data from the United Nations Conference on Trade and Development, surpassing China’s figure of US$128bn for the first time this century and underlining its allure to global portfolio and institutional investors. Policy clashes Still, achieving further strides will not be easy. Since its formation in 1967, ASEAN has progressed with stultifying languor. Formal summits are few and far between. Trade barriers were allowed to develop, cloistering one country’s energy, transport, mining, and financial sectors from the next’s. Deregulation and liberalisation seemed pointless when every state was engaged in protectionism. The AEC aims to do away with all of this. There is recognition at the official level that protectionism is not an answer. “The policies ASEAN governments pursued in the past clashed with the urge to boost regional integration,” said Tony Nafte, senior Asia economist at CLSA. “Almost every regional nation state is guilty of protecting its own industries and resources at the expense of greater regional trade. All this did was to undermine their own competitiveness.” The region has lagged as a result. In its latest yearly outlook, published in March, the Asian Development Bank tipped Asia’s economy as a whole to expand by 5.7% this year and next. ASEAN, by contrast, is set to grow by 4.5% in 2016 and 4.8% in 2017, far short of the rates of growth prevalent in India and, for all its woes, C

The more things change, the more they stay the same. Since Chinese President Xi Jinping first called for the creation of a new multilateral development bank at a speech in Bali in October 2013, the international community has been wrestling with the implications. Would the Asian Infrastructure Investment Bank be an extension of China’s soft power? Would it follow the same governance and sustainability standards as the established MDBs? Would it threaten the US-dominated global financial system that has been in place since the Bretton-Woods agreement of 1944? Almost three years later, the answers to those questions remain unclear. The AIIB has won the support of the vast majority of the international community, despite the reluctance of the US and Japan (the ADB’s biggest shareholders). A total of 57 governments signed up in 2015, and another 30 are looking to follow suit, the AIIB President told Reuters in March. The huge amount of global attention has been a diplomatic coup for Beijing, but the bank has so far been careful to stick closely to the established script. The AIIB’s first loans will be in US dollars, rather than renminbi – as many observers had speculated – and the bank’s top management includes former ADB and World Bank executives, pointing to a desire to work in partnership rather than competition with the established MDBs. The AIIB’s first President, Jin Liqun, is himself a former ADB executive, having served as a vice president from 2003–08. “We will do our best to promote broad-based economic and social development through sustainable infrastructure investment in the Bank’s member countries,” Jin said in a speech at the AIIB’s inauguration ceremony in January. The AIIB officially opened for business in January and is still recruiting investment specialists, but is due to approve its first projects at its next board meeting in June. One of its first investments is likely to be a co-financing with the ADB and the UK’s Department for International Development. The next section of Pakistan’s M4 motorway is out to tender, with bids from contractors due by May 23. (See below.) The bank is planning to approve US$1.2bn of financing in 2016, and is also discussing almost a dozen co-financings with the World Bank Group, it said in April. Much like the other MDBs, it plans to raise funds for its disbursements in the capital markets, initially in US dollars, although the AIIB has not set a timetable for its first issue. Michael Dee, a former Morgan Stanley and Temasek Holdings executive, is on board as senior financial adviser. “The challenge, of course, is that even with the arrival of these two new institutions the gap remains large. It’s going to be critical that we all collectively work on how we can use our balance sheet to leverage more investment in infrastructure across the region.” Jin has pledged to make the AIIB “lean, clean and green”, promising quicker project approvals and a streamlined institution. While that could be read as a criticism of the ADB’s bureaucratic procedures, the selection of the first projects points firmly to a collaborative stance. Jin is also keen to dispel any fears that the new bank will cut corners when it comes to lending safeguards and governance standards. “We will do our best to promote broad-based economic and social development through sustainable infrastructure investment in the Bank’s member countries. We will do our best to protect the environment and take care of the people in project areas,” Jin said in a speech at the AIIB’s inauguration ceremony in January. Standards A co-financing will allow the AIIB to begin lending quickly, since the due diligence has already been completed by the ADB, but offers little guide of the AIIB’s own policies to appease its critics. The US, notably, continues to call for scrutiny of the new bank’s standards. Treasury secretary Jack Lew, writing in Foreign Affairs on April 11, said it was “paramount” to include the standards and lessons learn

Worries over China’s slowing growth were at the centre of the turmoil in global markets at the start of 2016, as a slump in mainland stock markets compounded fears of waning demand from the world’s second-biggest economy. A bleak outlook for China is a big problem for Asia, where many of the region’s economies rely on exports to China and are exposed to any reversal of global capital flows should foreign investors sound the retreat. But recent news has been more positive, with stronger export figures for March adding to a rebound in investor confidence. Having slid against the dollar in 2015, currencies across Asia’s emerging markets – including China – are showing signs of stability. The ADB in late March downgraded its outlook for China’s GDP growth to 6.5% in 2016 and 6.3% next year, noting that the slowdown has dragged regional growth rates down by about 0.3 percentage points as a result of the strong linkages across Asia. “It’s hard to discern a catalyst that would lift Asia from its middling growth rates. For this, structural reforms are needed. Only then will things begin to change, truly. And only then will a market rally be sustained.” The bank, however, continues to argue that China can escape a hard landing as it rebalances its economy. “China is in a natural slowdown after years of rapid growth, but a sharp fall is very unlikely,” said Shang-Jin Wei, the ADB’s chief economist. “There are lots of issues to work on, but in a crisis China has a lot of tools it can use – both fiscal and monetary.” The ADB has been a strong advocate of structural reforms in China for years, and Wei welcomes the progress that has been made in improving productivity and stoking domestic consumption. In a release accompanying the bank’s Asian Development Outlook report, the ADB said the government’s “more gradual” approach to tackling overcapacity would help avoid more extreme fallout, noting that cutting capacity in the iron and steel, coal mining, cement, shipbuilding, aluminium, and flat glass industries by 20% might eliminate as many as 3.6 million jobs. Wei sees recent moves in Chinese stock markets and the renminbi as little more than “noise” for investors. The inefficiencies in mainland capital raising mean that listed companies are not representative of the broader economy, while the currency has moved “a step closer to its fundamentals”. Other economists broadly agree. Fitch expects growth of 6.2% in 2016 and 6.0% in 2017 but notes that China has the “financial and administrative resources to avoid a hard landing”. Analysts led by Andrew Colquhoun see the renminbi losing no more than 5% against the dollar in the remainder of 2016, according to an April report, but warn that rising leverage is adding to “systemic vulnerability”. Temporary relief? Morgan Stanley economists in March reported “encouraging signs of stabilisation” in China, while Barclays analysts revised up their below-consensus outlook for Chinese growth, noting the impact of stimulus policies. In all cases, however, a more encouraging outlook on China comes with stern warnings that the rebound in market sentiment might not be sustainable. “Without a fundamental change in the global economic environment – which we do not predict – the current episode is again likely to give way to one of higher volatility and spreading angst,” said Barclays economists led by Christian Keller in late March. The IMF in April warned that risks to global growth “are now more pronounced”, citing a deeper slowdown in China and a return of financial turmoil as two of the greatest risks. Wei at the ADB also cautions that the current period of calm may be short-lived, saying there is still a risk of a “surprise” on the scale or timing of US interest rate increases. “In the last few weeks markets seem to have found a common ground in US rates, but this may be temporary relief,” said ADB’s Wei. “Countries need to focus on attracting FDI, not just portfolio flows.” Frederic Neumann, co-head of As

The ADB’s treasury department is increasing its funding activities and focusing on local currencies as it responds to growing demands for the bank’s assistance. Pierre van Peteghem, ADB treasurer, said the bank faced higher borrowing costs as a result of distortions in the global capital markets over recent months. “Funding costs with respect to Libor for all MDBs, including the ADB, have increased significantly. This is related mainly to the inversion of the US dollar swap curve,” said van Peteghem, who estimates that the bank has faced an overall increase of 10bp–20bp in its borrowing costs. The bank’s funding programme this year stands at US$20.6bn, of which it has already raised more than 50%. “Market access is not at all compromised, but of course it comes at a slightly higher price,” said Peteghem. US dollar benchmarks account for the vast majority of the bank’s funding, but the treasury department is also keen to access local markets to match the loans it extends to its clients. The ADB made disbursements in 2015 and the beginning of 2016 in renminbi, Indian rupees, Thai baht, Philippine pesos and Georgian lari. “Loans denominated in local currencies are now one fourth of our non-sovereign transactions,” said van Peteghem. “One of the major initiatives for the treasury going forward is developing that side of the market.” The ADB has issued in the offshore rupee, or Masala, market, and is working on its second Georgian lari bond. It has also expressed an interest in returning to China’s Panda bond market, where it sold bonds in 2005 and 2009 to finance projects in mainland China. “We are in extensive dialogue with the Chinese authorities,” said van Peteghem. “This dialogue has been extremely constructive, and it is my expectation that we will soon be able to achieve some kind of compromise that will allow the ADB to reaccess the Panda bond market.” The combination of the bank’s ordinary capital resources and the concessional lending resources will also strengthen the ADB’s liquidity and capital base. The three major rating agencies have all affirmed the ADB’s Triple A ratings since the capital combination was approved at the 2015 meetings. Standard & Poor’s said the ADB’s risk-adjusted capital ratio would “improve significantly” after the merger. “This is mainly due to the substantial increase in equity, decreased concentration risk of the consolidated portfolio, and reduction in single country exposures due to diversification,” S&P analysts said in a July 2015 ratings note. Van Peteghem said that the bank will issue more Green bonds this year to finance its expanding climate finance portfolio. The bank has issued just one US$500m benchmark in March 2015 and has a target of channeling US$6bn of funding a year to climate-change projects by 2020. “You can expect at least one Green bond this year, more likely two,” said van Peteghem. To view all special report articles please click here and to see the digital version of this report please click here. To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com.

Japan, the ADB’s biggest shareholder, is ramping up its support for Asian infrastructure with commitments totalling US$6.5bn from the Japan International Cooperation Agency. JICA will sponsor a major new fund focusing on “quality and sustainable” infrastructure, named Leading Asia’s Private Infrastructure, or LEAP, which will go towards supporting private sector investments. The ADB will manage the fund, and expects to mobilise a total of US$6bn, once the usual leverage and co-financing multiples are applied. JICA is also providing another US$5bn over the next five years to support long-term infrastructure projects through co-financing to sovereign borrowers. The ADB has pledged to match that commitment with another US$5bn of its own resources. Some inside the bank say the Japanese initiative is a response to the arrival of the Asian Infrastructure Investment Bank and to China’s growing presence in Asia’s infrastructure arena. Japan and the US, who between them control over 31% of the ADB’s subscribed capital, are the highest-profile holdouts from the AIIB, the new multilateral conceived by Chinese President Xi Jinping. Even before the AIIB becomes fully operational, China beat a Japanese bid for a US$5bn high-speed rail project in Indonesia, using finance from China Development Bank to support China Railway International and a consortium of Indonesian companies. Japanese contractors had long been considered the favourites for the project before the Indonesian government’s decision late last year. With that in mind, support for “quality” infrastructure could be read as a way to promote Japanese exports in future projects over the lowest-cost solution. Others see the Japanese investment as effectively a capital raising for the ADB that avoids placing the burden on other member governments. The LEAP fund will be structured as an ADB trust fund and managed by the bank’s private sector operations department, allowing the ADB to scale up its support. To view all special report articles please click here and to see the digital version of this report please click here. To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com.

The Asian Development Bank’s 49th year of operations is shaping up as a calmer period for its president, Takehiko Nakao. Having won support for a groundbreaking capital restructuring last year and weathered the arrival of new players on the multilateral scene, 2016 is a chance to focus on the future. The Manila-based lender is laying the foundations for an expansion that will take its annual approvals from US$13bn to US$20bn by 2020. Green projects and Asia’s poorest countries are set to be the big beneficiaries, but Nakao is also honing the bank’s technical expertise to ensure it remains relevant as the region becomes richer. “Unless we can introduce better technologies and better expertise, our relevance will be limited,” said Nakao at an interview in the bank’s Manila headquarters. “I have a very strong view on that. Our money is limited anyway, compared to the vast needs of financing for infrastructure. We should combine our knowledge and expertise with our financing.” “Without China as a borrower, the ADB’s relevance in Asian development is much smaller, so it’s better to keep a strong partnership with China at this moment.” The ADB is looking to reduce its use of external consultants and upgrade its technical knowledge, with a view to passing on that expertise as a service to member countries. The bank is seeking experts for renewable energy, smart grid, transport and water projects, among other positions. Nakao’s comments point to a focus on securing the ADB’s long-term future in a region where growing wealth threatens to reduce the relevance of a multilateral development bank. Rather than simply providing capital, the bank aims to be seen as a partner, working with countries to introduce new technologies or financing solutions that can then be replicated on a bigger scale. “We need to remain relevant through our expertise. As Asia develops, a lot of our member countries can finance themselves,” said Nakao. The bank’s relationship with China is a case in point. The ADB’s latest country partnership strategy, timed to match China’s own five-year plan, calls for a focus on environmental initiatives and rural development. “I really feel there is very strong interest among European companies for business and investment in Asia. They are also looking to increase the investment from Asian companies into Europe, and some interesting technology cooperation.” “People may say that China is already more developed and they can use internal resources to support their people,” said Nakao. “But we can help China by using our expertise, which we have developed by supporting other countries.” Several of the ADB’s member governments have cut their use of the bank’s assistance entirely as their economies have developed, including South Korea, Taiwan and Hong Kong. Malaysia no longer borrows from the ADB, although it has not formally “graduated” to the same advanced economy status. Nakao does not foresee China graduating in the near future, but acknowledges that the scale of the country’s economy means the ADB’s support must offer more than just capital. The ADB approved loans totalling US$1.7bn to China last year – a drop in the ocean for a country with a GDP of US$8.8trn in 2015. “It’s a very small number, so we must target projects that can be replicated. Our focus must be on the biggest development impact,” said Nakao. Lending to a highly rated country such as China has other advantages for a development bank. “By lending to China at a spread over our funding cost, we can finance our operations and some surplus can be used for supporting poorer countries. And by having China as a borrower our asset portfolio becomes more balanced and stronger, so it is easier to get a higher rating,” said Nakao. “Without China as a borrower, the ADB’s relevance in Asian development is much smaller, so it’s better to keep a strong partnership with China at this moment.” Capital combination In the immediate future, Nakao is looking to wrap up the next rep