Despite the best efforts of Shinzo Abe, Japan is declining. The prime minister’s much-vaunted three arrows of quantitative easing, inflation targeting and structural reforms are the boldest attempt in a generation to invigorate the country’s economy. Yet even if they are highly successful, they are unlikely to fully counterbalance Japan’s demographics.
The country’s population is falling, with the number of children being born dropping for the 33rd straight year in the 2013-2014 fiscal year, according to the internal affairs ministry. The Health and Welfare Ministry estimated in 2012 that Japan’s population is set to drop by about one million a year under current trends. In other words, by 2030 Japan’s population of 127m is set to fall to roughly 111m. By 2050, it will be 91m. And well over 30% of that number will be elderly.
Set against that outlook, the chances of Japan ever again enjoying anything beyond meagre economic growth rates looks slim.
Yet Japan’s companies, banks and investors are some of the most cash rich in the world. And they are not interested in declining along with the populace. For several years they have been acquiring abroad, seeking alternative areas to invest. Increasingly this activity is focusing on the Association of Southeast Asian Nations (Asean) area.
Asean is an appealing target. In many ways it offers a direct contrast to Japan. Where Japan’s population is aging and its birth rates collapsing, Asean nations are largely young and growing fast. Where Japan is cash heavy and highly developed, the others are capital-starved and desperate to develop beyond emerging status.
Japan has had financial links to the region for years. Many Japanese auto-makers have established operations in Thailand, for example, and Japan’s multilateral and export agencies frequently fund projects in South-east Asia. Experts believe that what has been seen to date is just a fraction of what is likely to take place.
There are already signs of this acceleration, even as Japanese companies begin to de-emphasise China, their other traditional investment target.
In May last year, Sumitomo Mitsui Financial Group (SMFG) bought a 40% stake in Bank Tabungan Pensiunan Nasional (BTPN) of Indonesia for $1.5bn from private equity company TPG, while in December Mitsubishi UFJ Financial Group (MUFG) purchased 72% of Bank of Ayudhya in Thailand for $5.31bn, marking the largest acquisition by a Japanese bank in South-east Asia.
All told, Japanese foreign direct investment (FDI) into Asean was the second largest of any country or region in 2013 at $22.87bn, lagging behind only the European Union as a whole. And its interest is accelerating. It invested $4.7bn into Indonesia last year, the largest amount of any country and almost double the $2.5bn it spent in 2012.
Japan is serious about Asean, and looks likely to become even more so.
Chasing growth
In recent years, Japanese companies have increasingly sought to build their presence in China and Asean alike.
However, over the past 18 months China’s appeal has weakened, victim of a combination of worsening relations and rising labour costs. Japan’s FDI to China fell to $6.5bn in 2013, less than half the $13.48bn registered in 2012.
China’s diminishing allure has motivated Japanese companies to plough even more resources into Asean, to take advantage of the region’s low-cost work force and high-growth markets.
“We deal with gigantic auto-makers and high-tech companies and consumer retail companies; all of them are seeking business opportunities outside Japan, and their favourite destinations are Asean and China,” says Yoshikazu Kato, head of banking for HSBC in Tokyo.
Most large Japanese companies have set themselves minimum overseas targets of anywhere between 30% and 80% of total sales. Asean is a natural home for this, offering a multifaceted appeal. First, it’s relatively close, at least compared to the US or Europe, making for fewer logistics and transportation issues.
Secondly, the economies there are growing fast – the Philippines reported economic growth of 7.2% last year, Indonesia’s was 5.78% despite some hefty mid-year volatility, and Vietnam registered 5.42%. Even Thailand’s disappointing 2.9% was well ahead of Japan’s 0.7% growth, which came on the back of the largest concerted set of growth policies in decades. This expansion means the countries’ middle classes are growing, meaning millions of potential new customers for Japanese firms.
Lastly, the people of Asean are largely welcoming of Japanese companies, individuals and their money. Japan’s leaders are well aware of the possibilities. Abe’s first foreign trip after becoming prime minister in December 2012 was to South-east Asia, and he also hosted an Asean summit meeting in Tokyo in December to commemorate 40 years of cooperation between the South-east Asian nations.
HSBC’s Kato says several of its Japanese clients in the automotive, food and beverage, information technology and consumer retail sectors are considering sizeable capital injections into Asean subsidiaries, seeking business alliances with local distributors in the region, and in some cases weighing up potential acquisitions. Forming such alliances helps Japanese companies get immediate access to the local production and distribution networks of local businesses, giving them a big leg up in selling more of their products.
One example is Japanese trading house Itochu, which as Asiamoney went to press was reportedly close to investing into CP Pokphand, a Hong Kong-listed but Thai-headquartered food produce company owned by Thai billionaire Dhanin Chearavanont. Observers say the alliance would help Itochu expand its food business in Asia’s fast-growing economies. Kato believes other companies could well follow, buying shares in influential regional companies to build their influence.
Vietnam is another recipient of Japanese investment. From receiving only $445m of FDI in 2010, the country gained $4.45bn last year, on the back of major Japanese investment projects such as the $2.8bn Nghi Son petrochemical oil refinery and a $650m project by tyre-maker Bridgestone.
Observers say Vietnam appeals to Japan because of its cheap labour force and easy recruitment. The country’s traditionally peaceful nature is also a draw – although this was subverted by violent anti-China rioting in May after the country moved an oil rig into disputed waters. The rioting caused billions of dollars of damage through arson and looting of factories. Several were Korean and Japanese facilities, which the rioters seemingly mistook as being Chinese.
Banking on Asean
Japan’s financial industry is similarly interested in South-east Asia.
The country’s three megabanks have coffers full of cash yet lack much local interest in borrowing it. Instead, they have traditionally stuffed capital into low-yielding Japanese Government Bonds (JGBs) and equity portfolios to make returns, but both investments are becoming uncertain.
Buying and holding JGBs is a low-return game these days, as the government sale of large sums of the debt is absorbed by the central bank effectively printing money to suck the bonds up, keeping yields at record lows. Meanwhile equity investments are inherently risky, and leaning on them too heavily is hardly the sort of activity sober, responsible financial institutions should undertake.
So the banks are looking to lend offshore. And increasingly, they are looking to do so to Japanese companies setting up operations in Asean and also to local customers operating high-growth companies. The trouble is, Japan’s banks lack on-the-ground presence and relationships. And building them will take time.
“We will definitely see more M&A and alliances from Japanese banks into Asean, because they need to buy time,” says a senior investment banker familiar with Japan. “They want to catch up with HSBC, Citi and Standard Chartered in the region but opening branches and getting regulator permission is very time consuming. It’s often a lot easier to buy or ally to one bank with a branch network and employees in place already.”
Targets of opportunity
MUFG and SMFG’s dips into the markets of Thailand and Indonesia, respectively, are probably just the beginning.
For a start, each bank is likely to look for opportunities in the country their rival has just opened up in. Indonesia, with a fast-growing banking sector and huge population, is likely to be extremely tempting for MUFG. The opportunity for them to expand into other countries certainly exists. In July the Philippines changed its banking laws to let foreign lenders buy local banks wholesale (see story on page 28).
Vietnam in particular has benefited from such FDI, punctuated by Mizuho Financial Group and MUFG buying minority acquisitions in Vietcombank and VietinBank in 2011 and 2012, respectively. The interest makes sense to a large degree. Vietnam’s banking sector is in dire need of greater capitalisation, while Japanese companies have begun switching more investment away from China and into Vietnam.
The willingness of Japan’s banks to buy minority stakes in Vietnamese and Indonesian lenders is telling of how much they are prepared to do to expand. Basel III requirements take a dim view on one bank owning a minority stake in others. The regulations require such stakes to be fully deducted against capital held in reserve, meaning banks have to put more money aside. This has lessened the appeal of minority stakes among lenders across the world.
But liquidity is not an issue to Japan’s banks; access to growth is. They may decide it’s worth taking minority stakes in more Asean countries if it grants them access to the economic potential and helps them support the Japanese companies increasingly investing there.
It’s also worth remembering that Asean’s fast-growing markets are just as appealing for insurance businesses as they are to banks. Nippon Life Insurance spent Rph4.87tr ($423.9m) on a 20% stake in Indonesia’s mid-sized insurer Sequis Life on May 21. More deals are likely to follow.
Institutional flows
The growing financial links between Japan and Asean don’t stop with FDI and banking. Increasingly, Japan’s vast institutional investor base is looking at regional opportunities.
Since late 2012 and early 2013 Japan’s retail funds, or toshin funds, have increasingly sought offshore investment opportunities to make better returns. The nation’s institutional investors, pension funds, insurance companies and latterly its public funds have gradually followed.
“In May there were discussions in the Diet about the GPIF (Government Pension Investment Fund) making further inroads into overseas allocations and there were announcements made to its board too, which suggests a diversification of assets is getting closer,” says Andre De Silva, head of Asia-Pacific rates research at HSBC.
De Silva says Japan’s institutions and politicians are becoming increasingly concerned by the concentration risk of being so heavily exposed to domestic investment holdings, which take up approximately 92% of Japanese funds.
Discussions have revolved around further reducing the allocation of public-sector funds to JGBs, from their current benchmark weighting of 60% to 40%. This would potentially mean dropping it to 32% given that the funds have flexibility of eight percentage points when it comes to asset allocations.
The GPIF has $1.27tr in assets and most likely already sits on the 55% JGB ownership as of 2013-end. Were it to reduce its holdings to 40%, that would potentially free up $190bn in capital to be allocated elsewhere.
Most of that money would find its way into large, liquid markets such as US Treasuries, sovereign euro issues and gilts, and large equities, but Asean would likely gain a portion too. Countries such as Germany and the Netherlands are seeing their yield curves fall and flatten, to the point that returns are no longer much above those of JGBs. German 10-year bunds, for example, are trading at roughly 1.2% versus the 54bp of equivalent JGBs.
While large western bond markets will remain top picks for Japanese institutional investors, the diminishing returns they offer are likely to cause more money to be channelled to higher-yielding instruments. And Asean’s bond markets offer far more appetising returns.
There are already signs this is happening. According to De Silva, between September 2013 and May this year Japanese investors spent $1.83bn on Thai government bonds, $1.4bn on Korean bonds, $1.38bn on Indonesian debt and $1.3bn on Malaysian notes. These markets largely offer improved yields and, if timed correctly, the prospect of currency gains too. For Japanese investors with a higher-risk appetite, government bonds in these markets can look compelling.
More is likely, particularly as toshin funds seek higher returns and if Japan’s heavyweight pension players do truly reweight out of JGBs and into international assets. De Silva believes it’s an unparalleled opportunity for Asean sovereigns to use Japanese investor interest to develop their bond markets, provided they are willing to let foreign investors take larger stakes.
It has already begun. Indonesia, for example, last saw foreign investor ownership of government bonds peak at 36% in August 2011, and it appears to be trending close to that level again today. Similarly India has reportedly seen such foreign interest in its bonds that it is considering raising its $20bn cap on foreign institutional investor ownership of local bonds.
“If Japan’s investors gradually build their allocations in the region it could encourage the development of local bond markets, allowing governments to offer more frequent benchmarks and long-term debt,” says De Silva.
Mutual benefits
Japan’s desire to get exposure to Asean is the consequence of its historical success yet limited prospects, and the Asean’s prospects for success to come.
Japan looks likely to keep seeking opportunities to invest into the region, be it through alliances, acquisitions, lending or portfolio investment. As Asean seeks to evolve its economies through free-trade agreements, its governments would be prudent to harness this interest to help the region grow.
Done wisely, Japan’s capital convoy southwards could benefit its citizens and those of Asean alike.