Asia’s Fraught Frontier Framing
Through the first half Vietnam and Kazakhstan led Asian frontier stock markets on the Morgan Stanley Capital International Index with respective 8% and 15% gains, the former in line with the overall gauge’s increase. Bangladesh was up 3%, while Sri Lanka was among the worst performers with a near 10% loss. Since Pakistan returned to the main index, dedicated fund managers have been on the lookout for potential new entrants, with Mongolia often mentioned with dozens of listings in comparison with Cambodia and Laos with just a handful. However MSCI’s June review proposed no additions, as Vietnam remains on the “watch list” for potential upgrade to full emerging market status.
It noted positive steps to combine the Ho Chi Minh and Saigon stock exchanges and establish a central clearinghouse, modernize securities law, and open to full foreign ownership in sensitive banking and other sectors without a promotion timetable. Foreign inflows spike in advance to reflect greater global index weighting, but await direction as MSCI in the past criticized Vietnam’s “low liquidity” and is wary of strengthening Asia’s hold on the core roster. China, Korea, Taiwan and India already account for 60%, but even as it stays frontier Vietnam will become a larger component as Kuwait likely graduates by the end of this year. Kazakhstan in turn aims to solidify its position as the Astana International Financial Exchange was officially launched, with a wave of privatization offerings signaled in the coming months.
The US-China trade imbroglio reinforced longstanding production relocation to lower cost Vietnam, but export growth slowed in the first quarter with smartphone assembly down in the regional supply chain. As the International Monetary Fund’s July Article IV report cautions, it must upgrade productivity on digital technology, and also faces a looming demographic cliff as rapid aging sets in over the next decade. Economic growth has settled at 6.5% on inflation at half that figure, but weak domestic private investment and state-owned banks remain a drag.
Stock and bond market development are priorities to diversify funding sources, but public debt at 55% of gross domestic product, 5% below the statutory ceiling, continues to preempt commercial purposes. Treasury bonds are issued at 5-year maturity, but short-term bills are absent for cash and risk management and yield curve creation. The fiscal deficit is forecast to fall to 4% of GDP next year, assuming higher tax collection and reduced civil service spending, but the Fund recommends a tighter medium-term debt ceiling to avoid trouble.
Monetary and exchange rate policies are under close investor tracking, with runaway double-digit credit growth until this year. The central bank slammed the brakes, with consumer and real estate loan limits and asset-liability maturity mismatch prohibition, to slow the annual pace to 3% in June. With Asian Development Bank support, a domestic credit rating agency is in formation, and Basel II bank capital adequacy standards go into effect in 2020. An inflation target will be adopted over time, and the government’s asset management agency has whittled the reported 6.5% bad loan pile, but the bank equity shortfall is still estimated at 2% of GDP bolstering the case for wider foreign ownership. The currency was “broadly stable” against the dollar in the first quarter within a narrow 3% fluctuation band, but investors prefer a more market-determined rate. Intervention with $60 billion in reserves on hand has drawn scrutiny from the Trump Administration Treasury Department, which also criticizes anti-money laundering gaps.
The IMF recently completed a Kazakhstan visit as a successor to longtime President Nazarbaev took office promising to jump-start economic and financial sector agendas. He was formerly parliamentary speaker, and as a ruling party stalwart developed solid business community relationships favoring blue-chip IPOs in the oil and gas and other industries. Growth should approach 4% this year on broad pickup in hydrocarbon and mining exports, construction, and services. Inflation is in the 4-6% target range, and the central bank cut the policy rate in April as banks undergo a thorough asset quality review to determine outstanding risks likely to accelerate disposals at the state Problem Loan Fund. A May study by auditing firm KPMG suggests that private equity, with only a few deals worth $100 million annually, could be interested in privatization and distressed credit stakes that further raise the frontier market profile.
