All eyes on China?

Published: Jan 2016
Close up of horsefly

Treasurers will be watching developments in China closely in 2016; it is ASEAN, however, where we may yet see the greatest, most enduring changes. Treasury Today Asia asks industry experts what is in store for the year ahead and what treasurers should be doing now to prepare.

There should be no prizes for guessing which Asian economy the rest of the region – and indeed the world – will be watching most anxiously in the year ahead.

The slowdown in China has been on corporates’ minds for some time now; in the first quarter of 2015, 13% of respondents to J.P. Morgan’s survey of more than 80 treasurers in Asia Pacific cited the China slowdown as the biggest macroeconomic issue affecting their business outlook today. Two quarters later, and 48% rated it as their most significant macroeconomic issue. “It has affected a lot of the plans that corporates might have to achieve in terms of what numbers they have committed or budgeted. Clearly, it’s a pressure that many companies are feeling,” says Gourang Shah, Treasury Services APAC, J.P. Morgan.

The Asian century

Indeed, the difference between emerging market (EM) growth and developed market growth is narrowing. When you compare China and the US in terms of growth rate, Shah explains, there used to be a difference of around 6-7% between their GDPs. Now that is more like 4-5%.

Against this backdrop, any business that is supplying commodities to China – whether it is in Brazil, Russia, South Africa, Canada, Australia and so on – will be feeling the effects of the China slow down.

“A lot of components are also made in Asia so you will naturally see the effects here as well as in the big commodity producing countries,” says Shah. FX volatility is also an effect of the growth compression between EMs and developed markets. “There has been more money moving into dollars and at the same time, the Asian economies are not able to decrease their interest rates to spur growth because of the currency impact that is happening on the other side.” As a result, we are seeing more volatility.

According to Shah, however, this combination of factors will not affect the region’s domination. “We still believe that the 21st century is going to be the Asian century. All economies go through a cycle; China is no different.”

If China’s continuing growth story over the long term still looks assured, neither is its prospects in the immediate term quite as bad as some feared last autumn. The country’s frothy real-estate sector is a perennial risk, of course, but experts like Alessandro Theiss, a researcher and analyst at Oxford Economics, believe that most other areas of the economy are in relatively robust shape, a reality which is reflected in the markets. “We feel that the risk of a hard landing market participants have priced in following the August rout is relatively modest,” says Theiss. “This is because there is quite a lot of scope for policy still to be eased in China, especially fiscal policy. Overall we expect growth to slow, but in a relatively gentle, managed fashion.”

With all this in mind, perhaps we should consider what corporates should have on their ‘to do’ lists for the upcoming year. Shah highlights a few potential areas for consideration.

A bumpy ride

First and foremost, treasurers need to insulate their companies against the heightened volatility we have been seeing of late in global financial markets. “We are entering a volatile phase for the next year or so,” says Shah. “Essentially, it is similar to driving on a bumpy road, you have got to take control of the vehicle. In the same way, you need to have good infrastructure to manage cash funding risk and be prepared for the worst case scenario.”

For instance, if a company’s free cash flow generation is lower than expected, the treasurer must be able to manage the liquidity needs of the business accordingly. What’s more, he suggests, because it is possible that the environment will become still more turbulent, treasurers need to ensure they take a close look at risk management policies.

They will need to be especially watchful following the recent change to US interest rates. “There will be a lot of volatility,” says Priyanka Kishore, Senior Economist, Oxford Economics. “I don’t think any emerging market will be spared, but Malaysia tops the list not least because of its trade linkages to China, but also because of its foreign investors in terms of its bond holdings. We all saw what happened to Brazil, Turkey, and even India (an economy with very modest linkages with China) when the CNY was devalued last August. This is pretty much in line with what happens when market tensions increase – asset managers tend to stop differentiating on domestic fundamentals and they treat EM as an asset class.”

It isn’t all doom and gloom, however. China is opening up and is now beginning to allow corporates the freedom to convert and send funds cross-border (still subject in certain instances to regulatory approval). This of course opens the door to a whole new range of liquidity management possibilities for corporates in China. “There are now opportunities for companies to embed China in their global treasury infrastructure when looking at cash pooling,” says Shah. “Those that haven’t done so should prioritise this in 2016.” Corporates can now: start billing in RMB cross-border, hedge offshore because there is enough liquidity in the Hong Kong markets for RMB and move money between China and the global cash pool, whether it’s located in Singapore or London.

In the instance that sales no longer met expectations – as has been the case in China – corporates need to ensure they have some other source of liquidity to manage the short-term fall which this creates on the cash flow expectations. As a result of uncertainty, there is a tendency to build up cash on the balance sheet – particularly in EMs. “I think they will continue to do so for the next year, maybe longer,” says Shah. “But alternative funding sources needs to be lined up in case.”

At the same time, Shah explains, shareholders are expecting this cash to be deployed. “If you look at the more developed markets, there will be increasing activity on M&A as well as some investment in the business itself.” Sixty seven percent of respondents to J.P. Morgan’s recent survey agreed that they will be considering strategic uses of surplus liquidity such as share buy-backs, special dividends and M&A.

We are entering a volatile phase for the next year or so. Essentially, it is similar to driving on a bumpy road, you have got to take control of the vehicle. In the same way, you need to have good infrastructure to manage cash funding risk and be prepared for the worst case scenario.

Gourang Shah, Treasury Services APAC, J.P. Morgan

The past two decades have seen phenomenal growth in China; it is now a $10trn economy and, according to Shah, the economy will continue on its upward trajectory. It is just that it will be propelled by a different engine. “China is now going through a change where the service economy has overtaken the manufacturing economy for the first time.” As China goes more towards service and consumption, corporates need to be prepared to adapt their strategies.

Better together

A similar degree of flexibility is required by corporate treasuries operating in South East Asia, albeit for slightly different reasons.

The Association of South East Asia Nations (ASEAN) is made up of ten countries: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand and Vietnam. Ten countries which by no means present a uniform picture. “For corporates, there is fragmentation in terms of differences in capital market depth and banking sector scale which add a layer of complexity to the social, cultural and economic divergence,” explains Carli Renzi, Director, Financial Institutions at ANZ. Change has been on the cards for some time, however.

Envisioned to transform ASEAN into a region with free movement of goods, services, investment, skilled labour and freer flow of capital, the ASEAN Economic Community (AEC) progress has been ongoing for a while. The charter, signed by all members of ASEAN in 2007, set out the goal of achieving regional economic integration by the 31st December 2015, a date brought forward from the original 2020 aim. While China is endeavouring to integrate more with the global economy, then, ASEAN is endeavouring to integrate more with itself.

Despite some doubts circulating about ASEAN’s patchy history with the deadlines of such inter-country agreements, interest is certainly stirring prior to the AEC initiative. “Up until recently, ASEAN has been more of an insider term. When I’m talking at conferences or to banks from outside of Asia, I’m still defining what countries make up ASEAN,” says Renzi. “But I think it’s going to emerge prominently in its own right, especially now that AEC is ready to go.”

To illustrate what integration could mean for the region, Renzi compares Singapore and Laos. Whilst Singapore has been one of ASEAN’s success stories, Laos is a landlocked country, geographically disadvantaged when it comes to industrial growth, says Renzi. It is without a doubt that Laos differs considerably in terms of development when compared to Singapore. Singapore’s banking sector, for instance, has substantial regional presence whereas Laos is ASEAN’s smallest banking sector (less than $9bn).

“But when Laos is integrated into the ASEAN region, its location becomes strategically important; Laos is conveniently on the train line between China and Thailand, for instance.” With freer movement of goods and services, development – including in the country’s banking sector – would reach a faster pace than could be expected by Laos on its own.

With the ten countries all comprising different levels of development, as well as having different languages, cultures, currencies and so on, it’s really important that banks can equip their clients with local insights. Particularly around entry and exit strategies, supply risk, trade partnerships, distributor risk, and FX and interest rate risk.

Carli Renzi, Director, Financial Institutions, ANZ

This kind of disparity is currently spread across the whole region, and the benefits of integration therefore could be felt far and wide. But whilst waiting for the benefits of AEC to fully materialise, what can corporates operating in, or looking to invest in, the region expect?

A partnership approach

“With the ten countries all comprising different levels of development, as well as having different languages, cultures, currencies and so on, it’s really important that banks can equip their clients with local insights. Particularly around entry and exit strategies, supply risk, trade partnerships, distributor risk, and FX and interest rate risk,” says Renzi. ANZ predict that there will be an increasing demand for services that seamlessly connect to and within the region. The extent and complexity of service requirements, however, will depend on the customer’s stage of growth in the region, as well as their strategic goals. For this purpose, ANZ, in the bank’s annual whitepaper taken to SIBOS titled ‘Shaping the Future of ASEAN Banking’, identified how banks can approach the three sub-regions rising in line with ASEAN trade and financial integration: the high income economies (Singapore, Brunei and Malaysia), the mid manufacturing competitors (Thailand, Vietnam, Indonesia and the Philippines) and the Mekong frontier (Myanmar, Cambodia and Laos).

“For both MNCs and banks, these sub-regions are a way to cluster strategic objectives. A degree of local customisation, of course, is always going to be necessary but to be efficient, some economies of scale and categorisation are needed,” says Renzi. And it is without a doubt that corporates are keeping a close eye on where banks are investing and whether, and how, they are going to be in their present countries going forward.

Time and time again, ANZ’s Renzi explains, ‘reach’ comes up as a critical success driver for banks to be relevant in the relationship decisions of ASEAN’s MNCs. “This doesn’t necessarily mean banks need to have a full service franchise, however. There are selective ways of building a highly connected bank.” And according to ANZ, three broad banking approaches have emerged in the region. Firstly, the regional approach boasts substantial commitment and onshore investment to provide end-to-end services.

Next, there is the network approach which leverages key corridors, maintaining more flexibility to use other banks’ services when they don’t have the reach or capital onshore. There is also a partnership approach that has emerged. “This is the most common method where banks collaborate with other banks to support their customers’ offshore strategies,” says Renzi. Categorising banks isn’t to say that one strategy is better than another, however. “It also doesn’t mean the existence of rigid policies that don’t adapt. Rather, that banks having a core value proposition should be able to see out the differentiated impact of integration and the rapid financial development of ASEAN,” Renzi clarifies.

A bright future?

ANZ predicts that the creation of AEC will put regional growth at around 6-8% and, by 2025, ASEAN will emerge as a $4.5trn economy. Making the most of this opportunity, corporates investing and trading in the region will be looking to be provided with a complete suite of trade and hedging solutions in G10 currencies, as well as local currencies. “This means that banks need to align their infrastructure now and build those capabilities or move to partnerships so that they can accommodate these greater local currency volumes in the future,” Renzi explains.

The increasing demand for seamless connection to and within the region must be met – whichever approach is taken by a bank. Currently, cross-border banking in the region is a long way from seamless, but greater banking integration could enhance the service capability regionally, deepen inter-regional currency liquidity and improve economies of scale for banks. “For example, if you implement a regional structure, it results in better deals for customers.”

Looking ahead, ASEAN certainly seems to be a good bet. The true measure of success, however, will be how well treasurers deal with the present complexities in ASEAN rather than waiting for a dramatic change that is unlikely to occur overnight. And with more market volatility expected in the coming months as US interest rates rise and China continues to progressively open its economy to market forces, rising to that challenge is becoming ever more important.

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