A new era for DCM? | FinanceAsia

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The repercussions of recent black swan events are contributing to a new dealmaking landscape – one that continues to ebb and flow as geopolitical tensions rise and governments work to ensure that regional emissions fall.

As regulators respond to global inflation with interest rate hikes, market participants are adapting to the post-pandemic outlook, where the structural integrity of systemic lenders has been called into question; bank runs have been navigated; and a debt ceiling default, narrowly avoided.

“Volatility is the only constant,” Elaine He, head of Debt Capital Markets (DCM) Syndicate for Asia Pacific at Morgan Stanley, told FinanceAsia.

“Bond issuance has been slow as issuers wait on the sidelines because of uncertainty and the increasing rates environment,” Barclays’ head of Debt Origination, Avinash Thakur, motioned. “The biggest factor impacting dealmaking continues to be the US Federal Reserve’s tightening bias.”

“Even if there is a lot of liquidity in the market, the cost of borrowing is too high,” Singapore-based corporate practice partner at DLA Piper, Philip Lee, told FA.

“Most CFOs, CEOs or other corporate decision makers who are in their late 30s or early 40s, would not have even started their careers when interest rates were this high – in the late 1990s, or early 2000s. I suspect it will take some time for companies to adjust to this higher interest rate environment.”

But Sarah Ng, director for DCM at ANZ, holds some positivity amid current market uncertainty. She noted how recent headline events are influencing short-term market sentiment and shaping deal-focussed behaviour, for the better.

“We are seeing narrower open market windows. This has meant that issuers have had to adopt an opportunistic and nimble approach when accessing primary markets,” she offered.

“We did see a degree of caution and a flight to quality, especially post-Silicon Valley Bank (SVB) and Credit Suisse, but the sell-off was largely contained to specific bank capital products. What has been surprising, has been the speed of bounce-back in both primary and secondary market activities, with a robust pipeline of issuers and receptive investor base back in play,” she explained.

FA editorial board member and head of DCM for Asia Pacific at BNP Paribas, Manoj Agarwal, agreed that unexpected developments have made market activity very much “window-driven”.

“From an issuer perspective, being prepared and able to access markets at short notice, as and when market windows are optimal, has become important,” he said. 

Furthermore, he noted that market recovery has been much faster this year, compared to the protracted period of indecision brought about by the Covid-19 pandemic.

“Although the year has been peppered with volatility and disruption, market efficiency is also improving, helping to reduce the impact these events have on dealmaking,” he emphasised.

Going local

George Thimont, head of ESG Syndicate for Asia Pacific and leader of the regional syndicate (ex-Japan) at Crédit Agricole, observes three notable trends emerging amid the current, Asia-based dealmaking environment.

“Issuance is broadly down across the board – in spite of good demand from the investor community. From a sectoral perspective, the notable absentees are the corporates, and local market conditions in certain jurisdictions, such as South Korea, have offered good depth and pricing versus G3 currencies.”

Citing Bloomberg data, Agarwal noted that for Asia ex-Japan, 2023 year-to-date (YTD) G3 DCM volume as of mid-June was down by 35.4% year-on-year (YoY), with 2022 already down by 54% compared to the same period in 2021.

But he agreed that South Korea displays some optimism, given that its 2023 YTD deal volumes remain flat, compared to the same period in 2022.

In fact, some of the market’s larger institutions have been quite active overseas. In February, the Korea Development Bank (KDB) issued $2 billion in bonds via Singapore’s exchange (SGX) in what constituted one of the largest public market issuances by a Korean institution in recent years.

Debt from issuers such as sovereigns, supranationals and agencies (SSA) or state-owned enterprises (SOEs) has benefitted, managing director and head of Asia Pacific Debt Syndicate at Citi, Rishi Jalan, told FA. 

“We expect corporate issuance in the US dollar bond market to be a bit more robust in the second half of the year,” he explained. In the meantime, Jalan said that some issuers are selectively tapping local currency markets where financing terms are lower, such as in India, China and parts of Southeast Asia.

However, not everyone feels that Asia’s regional markets can cater to the demands of the significant dry powder at play.

“Most liquidity in the local currency market comes from the banking system,” Saurabh Dinakar, head of Fixed Income Capital Markets and Equity Linked Solutions for Asia Pacific at Morgan Stanley, told FA.

He is sceptical of the current capacity for local markets to meet the requirements of internationally minded issuers. However, he noted as an exception the samurai market, which he said had proven vibrant for some corporates with Japan-based businesses or assets.

“Larger long-term funding requirements can only be satisfied through the main offshore currencies, such as dollar securities,” he explained.

Turning to the regional initiatives that have been set up to encourage participation in Asia’s domestic markets such as Hong Kong’s Connect schemes – the most recent of which, Swap Connect, launched in May – Dinakar shared, “What we need to see is broader stability.… These developments are great, but for investors to get involved in a meaningful way, general risk-off sentiment needs to reverse.”

“There was huge optimism around reopening, post Covid-19. This has since faded as corporate earnings have disappointed and there has been no meaningful stimulus. The markets want to see policy stimulus and, as a result, corporate health improving. Performance across credit and equities will then follow.”

Sustainable momentum

One area of Asian activity that stands strong in the global arena, is ESG-related issuance.

In March, the International Capital Market Association (ICMA) published the third edition of its report on Asia’s international bond markets. The research highlighted that, in 2022, green, social, sustainability and sustainability-linked (GSSS) bonds accounted for 23% of total issuance in Asia – higher than the global ratio of 12%.

“Demand is still more than supply, and investors tend to be more buy and hold, so we’ve seen that sustainable bond issuance has been more resilient than the market as a whole,” shared Mushtaq Kapasi, managing director and chief representative for ICMA in Asia.

“ESG has come to form an integral part of the dealmaking conversation in Asia. Over 30 new ESG funds have launched here in 2023; the number of ESG-dedicated funds is up 4% YoY; and Asia makes up 11% of the global ESG fund flow as of 1Q23 – up from 5% a year ago,” said Morgan Stanley’s He. 

“The Hong Kong Special Administrative Region (HKSAR) government recently came to market as the largest green bond issuer in Asia so far this year,” she added.

Discussing the close-to-$6 billion green bond issuance, Rocky Tung, FA editorial board member, director and head of Policy Research at the Financial Services Development Council (FSDC), shared that the competitive pricing contained a variety of durations and currencies that “help construct a more effective yield curve that will set the benchmark for other issuances – public and private – to come.”

This, he explained, would not only be conducive to the development of green and sustainable finance in the region, but would specifically enrich Hong Kong’s debt capital market.

“ESG-related bonds can provide issuers with an additional selling point to attract investors,” Mark Chan, partner at Clifford Chance, told FA.

“They can demonstrate the issuer’s commitment to fighting climate change for example…. Issuers with a social agenda, such as the likes of the Hong Kong Mortgage Corporation (HKMC), can highlight their mission and objectives by issuing social bonds to enhance the investment story.”

In October last year, HKMC achieved a world first through its inaugural issuance of a dual-tranche social facility comprising Hong Kong dollar and offshore renminbi tranches, which totalled $1.44 billion.

“We are also seeing more bespoke ESG bonds such as blue and orange structures,” Chan added, referring to recent deals that the firm had advised on, including the Impact Investment Exchange’s (IIX) $50 million bond offering under its Women’s Livelihood Bond (WLB) Series; and issuance by China Merchants Bank’s London branch, of a $400 million facility – the first blue floating-rate public note to be marketed globally.

FA editorial board member and head of sustainability for HSBC’s commercial banking franchise in Asia, Sunil Veetil, noted that while Asian issuance fell in most segments, green sukuk and social bonds helped sustain momentum.

“For green debt, energy was the most financed project category in Malaysia, the Philippines, Thailand, and Vietnam, accounting for more than 50% of allocation,” he shared, citing a report by the Climate Bonds Initiative (CBI).

“In Singapore, which remains the undisputed leader of sustainable finance in Southeast Asia, around 70% of green debt went to buildings, mainly for the construction of green buildings, and to a lesser extent, for retrofits and to improve energy efficiency.”

“There continues to be regulatory support for ESG bonds, including grants provided by the Asia-based stock exchanges to list green bonds,” added Jini Lee, partner, co-division head for finance, funds and restructuring (FFR) and regional leader at Ashurst. 

A boom for private credit

Crédit Agricole’s Thimont told FA that Asian credit has remained resilient through recent global risk events. Private markets and funds are emerging as alternative sources of capital for those corporates with weaker funding lines, DLA Piper’s Lee observed.

Indeed, the further retrenchment of banks from lending has provided an opportunity for private credit players to swoop in and fill an increasingly large void. Globally, the sector has grown to account for $1.4 trillion from $500 million in 2015 and Preqin estimates that it will reach $2.3 trillion by 2027.

Once a niche asset class, investors are drawn to private credit’s floating rate nature which moves with interest rates and offers portfolio diversification.

Andrew Tan, Asia Pacific CEO for US private credit player, Muzinich & Co, earlier told FA that private credit players aim for investment returns of around 6-8% above the benchmark rate in the current environment.

The firm’s sectoral peers, including KKR, have argued that institutional investors should consider allocating as much as 10% to private credit. Alongside Blackstone and Apollo, the US global investment firm has added to its Asian private credit capabilities in recent years, while new players, including Tokyo-headquartered Softbank, have recently entered the market. In May, media reported that the Japanese tech firm sought to launch a private credit fund targetting late-stage tech startups and low double-digit returns.

Elsewhere in Japan, Blackstone recently partnered with Daiwa Securities to launch a private credit fund in the retail space, targetting individual high net worth investors (HNWIs).

Unlike in the US, where non-bank lenders now outnumber traditional financiers, “Apac remains heavily banked, so we expect to see ample room for private debt to grow in the region,” Alex Vaulkhard, client portfolio manager within Barings’ Private Credit team told FA.

He sees particular opportunity to serve the private equity (PE) space. “Although PE activity has been a bit slower in 2023, we expect activity to return, which will increase lending opportunities for private debt.”

Asia accounts for roughly $90 billion or about 6.4% of the global private credit market, according to figures cited by the Monetary Authority of Singapore (MAS) that highlight the market’s growth potential.

The biggest vehicle in Asia to date is Hong Kong-headquartered PAG’s fourth pan-Asia fund which closed in December at $2.6 billion.

However, overcrowding in some markets – notably India, where investors have amassed since new insolvency and bankruptcy laws came into force from 2016 – has made lenders increasingly compete for deals and acquiesce to “covenant-lite” structures, where investor protection is reduced.

But Tan, who is currently fundraising for Muzinich’s debut Asia Pacific fund – a mid-market credit strategy with a $500 million target, believes this only to be a problem in more developed markets such as Australia and is unlikely to become an issue in the wider region.

“If anything, the trend is in the direction of more conservative structures with increased over-collateralisation and stricter covenant protection,” he told FA.

Fundamentally, seasoned private credit participants are aware of the importance of covenant protection, so their likelihood to compromise on this is low, he added.

With monetary policies tightening at one of the fastest rates in modern history and recession looming in several markets, a key challenge for private credit is borrowers’ ability to service their debts.

“There is no doubt that default rates will go up and I would be cautious of cashflow lends with little or no asset backing,” said Christian Brehm, CEO at Sydney-headquartered private debt manager, FC Capital, calling for adequate due diligence when evaluating opportunities in the current environment.

“We would not be surprised to see an increase in default rates, but these are more likely to occur in more cyclical industries or among borrowers who have taken on too much debt in recent years,” Vaulkhard opined.

The managers suggested a tougher fundraising environment ahead, as the performance of fixed income instruments improves to offer limited partners (LPs) attractive returns.

What’s next?

The banking sector’s evolving regulatory landscape is also contributing to Asia’s changing DCM outlook.

Initially proposed as consequence of the 2008 global financial crisis (GFC) and with renewed rigour on the back of recent adversity across the banking sector, new capital requirements are set to be rolled out in the US and Europe as a final phase of Basel III. Often dubbed “Basel IV” for their magnitude, market implementation was originally scheduled for January 2023, before being delayed by a year to support the operational capacity of banks and market supervisors in response to the Covid-19 pandemic.

Experts caution that while more stringent banking regulation will challenge Asia’s traditional lending mix, it will also offer opportunity.

“There is a big amount of regulatory capital to be rolled out following the new Basel III rules, which will impact the type of debt to be issued,” said Ashurst’s Lee.

“We have been speaking to issuers who have been anticipating this uptrend as well in the coming years and are building in this scenario in their mid- to long-term treasury planning,” she added.

“Although the implementation of the Basel III final reform package was postponed in jurisdictions such as Hong Kong, those subject to it will no doubt be grappling with the new capital requirements already,” said Clifford Chance’s Chan, noting how its introduction will likely impact banks’ risk-weighted asset (RWA) portfolios.

“Aspects such as the raising of the output floor could potentially see some banks try to charge more for their lending,” he said.

Hironobu Nakamura, FA editorial board member and chief investment officer at Mizuho and Dai-Ichi Life tie-up, Asset Management One Alternative Investments (AMOAI), agreed that the new Basel reforms will lead to more scrupulous risk assessment by lenders, but how this will affect banks’ portfolio construction more concretely, remains uncertain.

“A heavy return on risk asset (Rora) requirements will likely impact banks’ risk asset allocations, region to region. [But] it is quite early to determine whether Asia is risk-off or -on at this stage, from a bank portfolio perspective.”

FA editorial board member and AMTD Group chair, Calvin Choi, proposed that if lending were to become more expensive for global players, there could be upside for regional banks.

“Updated Basel rules will impact global banks operating onshore, adding costs and making them less able to use their balance sheets. Local banks won’t have this constraint, so they will win market share,” he shared.

However, he noted that  for those Asian banks that want to participate in overseas markets, business will become more costly and compliance-heavy. “It will keep more local banks local.”

“All of this will mean a higher cost of borrowing and less capital available to banks…. It will create opportunities for non-bank lenders such as non-banking financial institutions (NBFI), family offices and private funds to fill the gap,” said DLA Piper’s Lee.

“With stricter capital requirements under ‘Basel IV’, we anticipate that bank loan funding will become more expensive for issuers. As such, we could see a return to capital market funding from issuers who have hitherto heavily relied on loan markets this year,” said ANZ’s Ng.

Choi added that this may even lead to Asia’s bond markets being viewed as more competitive than their global counterparts.

“Overall, the DCM market has become slow and stagnated,” Nakamura observed. “However, there are areas where funding is continually needed,” he said, pointing to the energy transition space as well as digital transformation. 

What exactly the new regulatory environment will mean for Asia’s market participants amid macro volatility, rising interest rates and escalating geopolitical tensions, remains unclear. But the developing outlook could offer those able to structure more creative facilities, more business; drive the advancement of Asia’s local capital markets; and support the region’s wider efforts to transition to net zero.

Proponents of private credit remain optimistic.

“Capital raising might cool down in the short-term, but the true private debt lending market is about to kick off,” said Brehm.

“We believe that there is a lot of growth ahead,” Barings’ Vaulkhard stated, sharing that conditions are likely to improve for lenders this year, with spreads widening, leverage falling, and overall credit quality enhancing. 

“We are only at the start of a multi-year growth journey,” Tan concluded.  

 

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In-depth: Exploring Hong Kong and Indonesia’s strategic potential | FinanceAsia

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Last week (July 26), Hong Kong Exchanges and Clearing Limited (HKEX) and the Indonesia Stock Exchange (IDX) signed a Memorandum of Understanding (MoU) marking strategic collaboration aimed at strengthening ties and exploring mutually beneficial opportunities across both markets.

According to the announcements, the partnership will see the exchanges meet regularly to develop new capital market products, including exchange-traded funds (ETFs) and derivatives; enable cross-border listings; and promote sustainable finance across the region, through shared best practices and the development of carbon markets.  

The releases point to the benefits made available through enhanced cooperation, including access to the international connectivity and vibrance on offer via Hong Kong’s marketplace, as well as the talent, creativity and innovative characteristics of Indonesia’s “new economy” participants.

Discussing the news, Singapore-based Clifford Chance partner, Gareth Deiner, who specialises within the firm’s South and Southeast Asian capital markets practice, shared with FinanceAsia his take on the opportunity presented by forging a deeper connection with the market that is home to world’s largest nickel supply.

“The mutually beneficial aspect of this collaboration is that it offers access to a wide pool of North Asian institutional investors and therewith, an enhanced liquidity pool.”

Shanghai and Singapore-based Clifford Chance partner, Jean Thio, acknowledged the significant number of Indonesian conglomerates that operate outside of the domestic market and seek access to North Asia’s investor community.

She highlighted her work in 2022, advising on the spin-off IPO of Chinese dairy farm operator AustAsia Group, a subsidiary of Indonesian agribusiness, Japfa, as demonstrating this point.

“International issuers look to Hong Kong as a way of accessing international institutional capital. The new collaboration complements other regional initiatives, such as Stock Connect.”

Hong Kong and China’s central banking authorities announced in May the launch of the sixth iteration of the regional bilateral scheme, the northbound channel of Swap Connect. The initiative is the first derivatives mutual market access programme globally and opens up institutional entry to China and Hong Kong’s interbank interest rate swap markets.

In terms of the current trends permeating Indonesia’s capital markets, Deiner shared, “Historically, Indonesia’s future-facing minerals – cobalt, copper and nickel – would be exported. But now these are proving key elements of Indonesia’s onshore energy transition story, as they are core components used in the manufacture of wind turbines, solar panels and electric vehicles (EVs).”

“As such, Indonesia has implemented bans on the export of unprocessed nickel ore, in order to facilitate the development of the EV supply chain onshore.”

Deiner and his team advised the underwriters of Harita Nickel’s IDR9.7 trillion IPO on the IDX in April, which media attributed to being part of a government push to privatise state-owned enterprises (SOEs).

Amit Singh, Singapore-based partner and head of Linklaters’ South and Southeast Asia capital markets practice agreed that the newly formed “super-connection” opens the door to meaningful, increased liquidity for Indonesian companies.

“Hong Kong also gains a valuable link with the growing mining and supply chain powerhouse that Indonesia is developing into,” he told FA.

“Mining, minerals and other supply chain-focussed industries are driving Indonesia’s IPO boom in 2023,” Singh explained, pointing to his involvement in Merdeka Battery’s IDR9.2 trillion ($620 million) IPO in April. The PT Merdeka Copper Gold Tbk subsidiary owns one of the largest nickel reserves globally and has a portfolio of EV battery assets across the Sulawesi region.  

“This trend is likely to continue and grow in the upcoming years, and Hong Kong is clearly seeking to position itself closely with Indonesia and its burgeoning strengths in these areas.”

Dual listings

Tjahjadi Bunjamin, Jakarta-based managing partner and head of the finance practice at Herbert Smith Freehills (HSF) partner firm, Hiswara Bunjamin & Tandjung (HBT), agreed that the MoU means that Indonesia will obtain greater access to Chinese issuers and the related international investment base.

“This is particularly important given the dominant role of Chinese companies in the EV ecosystem.”

He explained to FA that the collaboration further enables the exploration of dual listings by both parties: “Both will benefit from a more coordinated approach to listing in the two jurisdictions, as well as more clarity on listing requirements for issuers and investors.”

“Dual listings and increased regulatory cooperation will accelerate the maturation of the Indonesian capital markets, allowing them to more quickly adapt as deal sizes and investor interest and scrutiny in the market widens,” Singh added.

David Dawborn, HSF partner and senior international counsel at HBT, noted that a challenge for the partnership will involve the fact that Indonesia’s capital markets system remains primarily focussed on basic equity and debt securities.

“It could benefit from new ideas and products available through Hong Kong’s capital markets system, which is more flexible and easier to navigate in many aspects.”

In prior discussions with FA, experts have commended Indonesian regulators for their efforts to make the market’s domestic exchange more accessible and attractive as a listing destination.

In late 2021, the Indonesian financial services authority, Otoritas Jasa Keuangan (OJK), approved amendments to the listing regime to allow firms with multiple voting rites (MVR) to participate on the domestic exchange. The move signalled continued progress to bring Indonesia’s capital markets in line with other global exchanges, such as those of the US and Hong Kong, which have had dual class share frameworks in place since the 1980s.

Recent research by the Hong Kong Trade Development Council (HKTDC) citing Refinitiv data suggests that more than 70% and 25% of companies currently listed on IDX meet the minimum capital requirement for listing on Hong Kong’s GEM (which serves small and mid-sized issuers) and main board, respectively. “This implies that there is a huge potential pool of candidates for dual primary and secondary listing,” the report noted.

However, the research added that so far, “only three Indonesian companies domiciled in Indonesia are currently listed overseas, and none are listed in Hong Kong.”

Tech story

Poised to become the seventh largest global economy by 2030, Dawborn underlined Indonesia’s endeavours to become a regional leader for Southeast Asian capital markets, following its success as host of last year’s G20 summit, in Bali.

Already home to a variety of tech unicorns (companies valued at over $1 billion) including Blibli, Bukalapak, Traveloka and GoTo, Indonesia is fast-emerging as a Southeast Asian tech hub, with its internet economy expected to double in value to be worth $146 billion by 2025.

Experts suggest that Indonesia holds significant potential to elevate Asia’s prominence on the global tech stage.

“Where we are in the macroeconomic cycle, with interest rates at an all-time high following another bump by the Fed last week, the landscape is challenging – high interest rates are not the friend of the tech sector. But the minute that inflation starts to settle, I think we’re going to witness the next chapter of Indonesia’s tech story,” Deiner said.

“Traditionally, Southeast Asian companies have always thought of the US when it comes to tech, but the HKEX has worked to be increasingly accommodative for these firms and Hong Kong is starting to prove a very attractive listing venue for those active in biotech,” explained Clifford Chance’s Thio.

“So-called US stock orphan listings (where a company has no operations, investor relations or management in a particular market but chooses to list there) are becoming a real discussion point across the Asian IPO landscape. I agree that Hong Kong may become an increasingly compelling venue for tech firms. In doing so, it supports the regional sector growth story,” Deiner added.

The tech sector is also set to support Indonesia’s efforts in the sustainability space. The market published the first version of its green taxonomy in January 2022.

“The ESG frameworks and disclosure standards of listing venues have become a hot topic in the IPO execution process and in equity offering documents more generally, and the variation in ESG disclosure standards across different international markets is creating a degree of execution friction across transactions in different markets,” Deiner explained.

“I was interested to read that the exchanges highlighted ESG considerations in the MoU as this will hopefully present an opportunity for the two markets to converge on ESG standards.”

“If this leads to a greater uniformity in ESG disclosures across primary equity markets, this could really be a game changer for market activity, and would be a very exciting development to monitor,” he added.

“As Hong Kong already has more developed carbon related, ETF and derivative products and trading systems, Indonesia and the market’s investors will benefit from access to this knowhow and technology,” noted HBT’s Bunjamin.

Jakarta-based corporate partner and capital markets lead, Viska Kharisma, told FA that following the introduction of Indonesia’s Financial Services Omnibus Law in 2023, OJK has been considering marketing more types of offshore securities in Indonesia, including carbon-related instruments.

“We understand that OJK and IDX propose to issue a new carbon market trading regulation in the near future, which should facilitate access by international investors to carbon credit opportunities through Indonesian industrial and mineral companies,” she said.

Reflecting on the opportunity on offer as a result of the official partnership, Deiner shared, “Where there is a cross- or secondary listing as part of a primary offering on any two international exchanges, you’re going to have an element of friction between their respective listing standards and the requirements that one legal jurisdiction or one regulator will impose versus another – and in many ways, the art of dealmaking in large-scale equity capital market (ECM) transactions of this nature, involves getting these two pieces to fit.”

“There’s nothing particularly apparent that has created a roadblock between the markets until now, but then that’s why you have the MoU. Hopefully it will provide a robust basis to ensure that any future obstacles can be navigated or removed,” he concluded.

HKEX declined to comment beyond the press release. IDX, the Indonesian Chamber of Commerce and Industry (KADIN) and a number of Indonesian banks did not respond to requests for comment.

 

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Gallium and germanium: What China’s new move in microchip war means for world

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Flag of the US and China on a microchip.Getty Images
By Annabelle Liang & Nick Marsh
BBC News

China is due to start restricting exports of two materials key to the semiconductor industry, as the chip war with the US heats up.

Under the new controls, special licences will be needed to export gallium and germanium from the world’s second largest economy.

The materials are used to produce chips and have military applications.

The curbs come after Washington made efforts to limit Beijing’s access to advanced microprocessor technology.

China is by far the biggest player in the global supply chain of gallium and germanium. It produces 80% of the world’s gallium and 60% of germanium, according to the Critical Raw Materials Alliance (CRMA) industry body.

The materials are “minor metals”, meaning that they are not usually found on their own in nature, and are often the by-product of other processes.

Besides the US, both Japan and the Netherlands – which is home to key chip equipment maker ASML – have imposed chip technology export restrictions on China.

“The timing of this announcement from China is not coincidental, given chip export restrictions announced by the Netherlands amongst others,” Colin Hamilton from the investment firm BMO Capital Markets told the BBC.

“Quite simply, if you won’t give us chips, we won’t give you the materials to make those chips,” he added.

The constant tit-for-tat between the world’s two biggest economies has raised concerns over the rise of so-called “resource nationalism” – when governments hoard critical materials to exert influence over other countries.

“We’re seeing governments increasingly move away from the narrative of globalisation,” says Dr Gavin Harper, a critical materials research fellow at the University of Birmingham.

“The idea that international markets will simply deliver materials is gone and, if you look at the picture more broadly, Western industry could be facing a bit of an existential threat.”

Gallium arsenide – a compound of gallium and arsenic – is used in high-speed computer chips, as well as in the production of light-emitting diodes (LEDs) and solar panels.

A limited number of companies around the world produce gallium arsenide at the purity needed for use in electronics, according to the CRMA.

Germanium is also used to manufacture microprocessors and solar cells. It is also used in vision goggles which are “key to the military,” Mr Hamilton said.

However, Mr Hamilton added: “There should be enough in regional supply from base metal smelters to provide alternatives. The importance to top quality semiconductors is a harder one to solve, as China really is dominant. There will probably be some push for recycling.”

Last month, a Pentagon spokesperson said the US had reserves of germanium but no stockpile of gallium.

The spokesperson added that “The [Defense] Department is proactively taking steps… to increase domestic mining and processing of critical materials for the microelectronics and space supply chain, including gallium and germanium”.

Still, the Chinese export restrictions are expected to have a limited impact in the long-term.

A researcher looks at a gallium oxide wafer at Zhejiang University Hangzhou International Science and Innovation Center in Hangzhou, Zhejiang Province, China.

Getty Images

Although China is the leading exporter of gallium and germanium, there are substitutes for the materials in the production of components like computer chips, political risk consultancy Eurasia Group said.

There are also active mining and processing facilities located outside of China, it added.

The consultancy highlighted similarities to when China restricted the exports of rare earth minerals over a decade ago.

More exporters emerged and in less than a decade China’s dominance of the rare earths supply chain fell from 98% to 63%, according to Eurasia’s estimates.

“We can expect to see the development and exploitation of alternative sources of gallium and germanium, as well as intensified efforts to recycle these commodities and identify more readily available alternatives,” Anna Ashton, Eurasia’s director for China corporate affairs and US-China, told the BBC.

“That’s not simply going to be a result of China’s recently announced export restrictions,” she added. “It’s a result of expectations of growing demand, intensifying geostrategic competition and distrust, and China’s documented willingness to restrict imports and exports in service to political and strategic ends.”

In October, Washington announced that it would require licences for companies exporting chips to China using US tools or software, no matter where they are made in the world.

A piece of germanium.

Getty Images

China has frequently accused the US of “tech hegemony” in response to export controls imposed by Washington.

In recent months, Beijing has also imposed restrictions on US firms linked to the American military such as aerospace company Lockheed Martin.

Meanwhile, Western governments have spoken about the need to “de-risk” from China, which means being less reliant on it for both raw materials and finished products.

However, diversifying supply chains and building up the capability to mine and then, crucially, process metals such as gallium and germanium will take years.

In the long-term, mineral-rich countries, such as Australia and Canada, see the materials crisis as an opportunity.

Experts warn that weaponising resources and technological capabilities – as the US and China have both done – will also have global consequences when it comes to the environment.

That is because important new green technologies are reliant on these kinds of materials

“This isn’t a national problem. This is a problem that we face as a human race. Hopefully, policymakers can bring their best selves to the table, secure access to those critical materials that are really essential for the energy transition and we can start to tackle some of the challenges around decarbonisation,” said Dr Harper.

While the impact of the latest export controls will not be catastrophic for industry or consumers, experts warn it is important to pay attention to where the trend is heading.

“The man and woman in the street cannot relate to gallium and germanium,” says Dr Harper. “But equally, they care about how much their car costs or how expensive it will be to switch to green technology.”

“Sometimes very abstract policies happening in faraway lands actually translate into something that has a big impact on their lives.”

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Singapore hints at global chip market rebound

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SINGAPORE – June marked another dismal spell for Singapore’s manufacturing sector, with factory output falling 4.9% in the ninth consecutive month of contraction. But a shallower decline in electronics saw semiconductors and components revert to positive growth, stoking optimism that the global memory chip market is beginning to recover.

Data released by the Singapore Economic Development Board (EDB) on July 26 showed electronics output contracting by 2.9% in June versus minus-23.7% in May. Though the numbers showed year-on-year declines for all clusters except transport engineering, electronic modules and components and semiconductors grew 7.5% and 3.1% year on year respectively. 

The publication of Singapore’s factory results was coincident with an announcement by South Korea’s SK Hynix, the world’s second-biggest memory-chip maker, which said it saw early signs of the chip sector beginning to recover from a deep downturn amid robust demand for artificial-intelligence (AI) capacity, with rising interest in OpenAI’s ChatGPT seen as the main driver of demand. 

“The worst of the global electronics downturn may be behind us,” said senior economists Chua Hak Bin and Brian Lee Shun Rong of Maybank Investment Banking Group. “A modest export boost from China’s reopening and possible stabilization in global electronics demand” could bring about a fourth-quarter manufacturing recovery in Singapore, they said in a research note sent to Asia Times. 

Though Singapore’s non-oil domestic exports, seen as a barometer for external demand, declined at a steeper pace in June, by 15.5% versus minus-14.8% in May, exports to China including Hong Kong bucked the downward trend, with each registering an increase of 3.7% (3.1% in May) and 41.9% (minus-41.2% in May) respectively. The city-state’s exports to all other major markets declined in June.

“China’s reopening is finally giving exports some lift as seen in the improvement in shipments to China and Hong Kong. Nonetheless, the modest boost was insufficient to offset tepid demand from other regions,” Chua and Lee said. “Exports remain in the doldrums with few signs of a meaningful turnaround, which will continue to stymie manufacturing activity in the coming months.”

Singapore’s electronics cluster saw its output fall by a milder-than-expected 2.9% in June, its smallest decline since December 2022, while semiconductor output expanded for the first time since October 2022. But electronics exports declined for the 11th straight month at minus-15.9% versus minus-27.2% in May, with tepid demand for consumer electronics, computer peripherals and data storage.

A manufacturing recovery by the fourth quarter this year would “reduce the risk of a recession or double-dip downturn,” said Maybank’s Chua and Lee, who had earlier forecast that Singapore would fall into a second-quarter technical recession, which preliminary data showed was “averted despite the steep manufacturing fall since the start of the year.”

Economists had regarded a second-quarter technical recession, defined as two consecutive quarters of contraction, as being highly likely. A Bloomberg poll of economists predicted the economy would shrink 0.2% quarter on quarter. But gross domestic product (GDP) grew 0.7% year on year in the April-June period, up 0.3 percentage point from the first quarter thanks to resilient service-sector performance.

Though the city-state sidestepped a recession, economists remain gloomy on Singapore’s full-year outlook, with the aggressive tightening of monetary policies, particularly in Western economies, seen as a major export dampener. Singapore’s Ministry of Trade and Industry (MTI) has maintained its 2023 growth forecast at 0.5% to 2.5%, though analysts see a downgrade as highly likely. 

Despite growth in the doldrums, progress continues to be made on inflation. Core inflation, which excludes private transport and accommodation costs, cooled for a second straight month, dropping to 4.2% year on year in June, from 4.7% in May. Easing prices have prompted authorities to lower the trade-dependent nation’s overall inflation forecast for 2023 earlier this month. 

The ministry and the Monetary Authority of Singapore (MAS), the city-state’s central bank, revised their headline or overall inflation predictions to between 4.5% and 5.5% for the year, from 5.5% to 6.5% previously. Core inflation estimates remain the same, at between 3.5% and 4.5%, though private economists believe that figure could drop below 3% for the full year if trends continue. 

The central bank uses exchange rates, managed against a trade-weighted undisclosed basket of currencies from Singapore’s major trading partners, instead of interest rates as its primary policy tool to manage inflation. It has enacted five rounds of monetary tightening since October 2021 but opted against a sixth round of tightening during a policy review in April, defying most expert forecasts. 

Observers interpreted June’s lower inflation numbers as a vindication of the Monetary Authority’s decision to pause its streak of aggressive monetary policy. The central bank said this month it would not switch from “inflation-fighting mode” to “growth-supporting mode” as inflationary risks linger, though economists expect it to keep monetary policy settings unchanged at its biannual policy review in October.

“We expect MAS to maintain the current appreciation stance at the October meeting to contain still-elevated core inflation, even as price and wage pressures taper in the second half of the year,” Maybank’s Chau and Lee said. “The growth downturn is turning out to be shallower than expected, with a technical recession averted, and the prospect for a growth recovery in 2024 is improving.”

Tan Jing Yi, a senior country risk analyst at BMI Industry Research, told Asia Times he expects price increases “to continue tapering off on the back of declining imported goods prices as inflation in the city-state’s major trading partners ease. A moderation in global supply-chain frictions, energy and food commodity prices also serve as tailwinds to the overall disinflation story.”

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Italy joining China’s Belt and Road Initiative was atrocious move, defence minister says

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Italy's defence minister Guido Crosetto pictured in May at the Trento Economy Festival in Trento, ItalyGetty Images
By Alys Davies
BBC News

Italy made an “improvised and atrocious” decision in joining China’s Belt and Road (BRI) initiative, defence minister Guido Crosetto has said.

Mr Crosetto claimed the initiative had done little to boost Italy’s exports, making China the only winner.

China has previously said both nations have seen “fruitful results” as a result of the BRI.

Italy became the first developed economy to join the BRI in 2019 – a move criticised by its Western allies.

The global investment programme envisions connecting China with Europe and beyond through rebuilding the old Silk Road trade route.

Under it, China provides funding for major infrastructure projects around the world, in a bid to speed Chinese goods to markets further afield.

Critics see it as a tool for China to spread influence. Both the EU and the US expressed concern when Italy decided to join the scheme four years ago.

“The decision to join the [new] Silk Road was an improvised and atrocious act” that increased Chinese exports to Italy without having the same effect on Italian exports to China, Mr Crosetto told Italian newspaper Corriere della Sera.

He said Italy now needs to work out how to get out of the deal without damaging relations with Beijing.

“The issue today is: how to walk back (from the BRI) without damaging relations [with Beijing]. Because it is true that China is a competitor, but it is also a partner,” Mr Crosetto said.

As Beijing had become increasingly assertive on the world stage, Italy would have to think about how to withdraw “without producing disasters”, he said.

There has been intense discussion about whether Italy should remain in the BRI since May, when Prime Minister Giorgia Meloni said she wanted talks with China about possibly withdrawing.

It is set to be automatically renewed in March 2024 unless Italy makes a formal request to withdraw from it by December this year.

China’s foreign ministry previously said it believed “China and Italy should further explore their cooperation potential” under the BRI and “strengthen mutually beneficial cooperation to seek more fruitful cooperation results.”

In comments quoted in the English language edition of the state-affiliated Global Times newspaper in May, foreign ministry spokesperson Wang Wenbin added that the two nations have seen “fruitful results” in many fields as a result of the BRI.

Beijing has since launched a diplomatic campaign to try to persuade Italy to renew the deal by sending senior officials to the country to lobby its case.

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Indonesia seeks damage control after Musk snub

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JAKARTA – Indonesian Maritime Affairs and Investment Coordinating Minister Luhut Panjaitan is seeking a meeting with Elon Musk after the multibillionaire carmaker left him with egg all over his face by spurning Indonesia and choosing Malaysia for his Southeast Asian headquarters. 

Panjaitan had made the world’s richest man an irresistible target of the Indonesian government’s efforts to attract heavyweight investors to a country on the way to a major expansion into nickel-based batteries and electric vehicles (EVs).

But the talks went quiet in the latter part of 2022 and Malaysian Prime Minister Anwar Ibrahim’s announcement that Musk’s Tesla auto company was establishing a regional office and service center in Selangor, the state surrounding Kuala Lumpur, took the Indonesians by surprise.

Malaysia sweetened the pot by allowing Tesla to import its latest Model 3 and Model Y models, whose launch contributed to the firm raising its EV production to 441,000 units in the first quarter of this year, an 86% increase over the same period in 2022.

Anwar apparently gave nothing away when Panjaitan accompanied President Joko Widodo on a visit to Kuala Lumpur in early June which focused mainly on border issues and the welfare of Indonesian migrant workers in Malaysia. 

Sources close to Panjaitan said he only had an inkling of Musk’s move several days before the announcement, but that did little to diminish his annoyance at being blindsided.

Only days later, Indonesia’s Ministry of Communication and Informatics blocked Musk’s X, the social-media site previously known as Twitter, because it did not yet conform with the country’s strict laws against pornography, gambling and other online infractions.

Analysts sense a possible payback. Indonesia has 24 million Twitter users, the fifth-highest in the world after the United States (95.4 million), Japan (67.5 million), India (27.3 million) and Brazil (24.3 million).

Musk is clearly looking at Malaysia as a potentially fast-growing retail market, which may not preclude him from looking at Indonesia as a growing future source of EV batteries or other components derived from the processing of its rich sources of nickel, cobalt and copper. 

Malaysia head of car industry game

Malaysia has long had a mature auto industry. Toyota, Nissan, Honda, Volvo, Porsche, BMW and Mercedes-Benz already operate in Selangor and the government recently launched a Battery Electric Vehicle Global Leaders initiative to attract EV makers, which Musk termed “forward looking.”  

Since 2018, the Malaysian Investment Development Authority (MIDA) has approved 58 EV projects, worth US$5.8 billion, ranging from assembly plants to factories producing parts and charging components.

Unlike Indonesia, Malaysia doesn’t insist that investors have local partners. It also has an emerging EV ecosystem, with 1,000 charging stations around the country of 34 million people and plans to add 10,000 more by 2025, relying partly on Tesla’s help.

Indonesia, by comparison, has only 450 charging stations, most of them on Java. It will need 20,000 over the next two years to service a targeted 400,000 electric cars – and then to facilitate longer-distance travel outside of Jakarta. 

Panjaitan is undaunted by the latest turn of events. He says he plans to meet with Musk on August 2 and insists a Tesla investment is still in the cards despite the deal with a neighbor with which it shares a close, but often testy, relationship.  

That goes back to the armed conflict known as Confrontation in the early 1960s over Indonesia’s opposition to the creation of the state of Malaysia from the Federation of Malaya, a former British colony. 

Losing out to Malaysia is hard to swallow for Indonesians, aggrieved in 2002 when the International Court of Justice awarded Borneo’s hotly contested Sipadan and Ligitan islands in the Celebes Sea to Malaysia.  

Indeed, Indonesian media have said very little about the Tesla setback, a sign of embarrassment – or perhaps further evidence of the government’s control over information it doesn’t want widely disseminated. 

“If I were Musk, I would invest first in Malaysia,” says one Indonesian business analyst. “It has a higher per capita income, which means more EV sales, and a better road infrastructure. For now, Indonesia’s EV growth is around motorcycles.” 

Despite four rounds of meetings with Tesla in 2020-2021 – and a series of seemingly overly confident public statements – Panjaitan’s negotiating team, which also included his son-in-law, was unable to win Musk over. 

With President Widodo calling him a “super-genius,” even the Indonesian leader’s much- anticipated May 2022 visit to the tech mogul’s SpaceX complex near Brownsville on the Texas Gulf Coast failed to produce results. 

Musk did appear upbeat about future investment, but behind the scenes he was reportedly expressing concern about Indonesia’s “chaotic” regulatory framework and the high level of corruption, which has worsened in recent years. 

Shortly before the SpaceX visit, Panjaitan complained that Musk was making too many demands. “Tesla is dictating too much,” he said, stressing the need for the firm to meet domestic investment guidelines. 

The minister was initially pushing Tesla to build an energy storage system (ESS) plant in Central Java’s Batang industrial park, but Musk’s focus was solely on batteries and on partnering with environmentally friendly suppliers. 

Considered key to the future of the EV and electric-power industries, an ESS is a device or combination of devices capable of storing energy from solar panels and wind turbines that can be used at a later date.

Regulatory roadblocks

Musk was also put off by the government wanting EV investors to partner with the state-run Indonesian Battery Corporation (IBC) that will allow for integrated development and speed up technology transfers, always an important issue for Indonesia.

IBC is a holding company comprising Indonesia Asahan Aluminium (MIND ID), gold and nickel miner Aneka Tambang (Antam), petroleum company Pertamina and utility firm Perusahaan Listrik Negara (PLN), each of which holds a 25% stake. 

Panjaitan claimed in August last year that Tesla had signed contracts worth about $5 billion to buy materials for its lithium batteries from processing facilities concentrated in nickel-rich eastern Indonesia, but he offered few details. 

More bad news for Indonesia is the mounting obstacles to a proposed free-trade deal with the US on critical minerals used in the EV battery supply chain, which would open the way for tax credits under the Inflation Reduction Act (IRA). 

As the world’s largest producer of nickel, one of those critical minerals, Indonesia has banned exports of nickel ore to force the development of domestic nickel-based plants producing stainless steel and lithium-ion batteries.

Although US free-trade-agreement (FTA) partners account for less than 10% of global nickel production, analysts say Washington will likely push Indonesia to limit the use of export bans, which now also apply to bauxite and could soon affect tin and copper concentrate.

Indonesia is currently appealing a World Trade Organization ruling that export bans and domestic processing rules amount to unfair trade practices, which cause market disruptions but are considered key to Indonesia’s industrial future.

A further hurdle is presented by Chinese involvement in the nickel industry, with steelmaker Tsingshan nd other Chinese firms the dominant investors in the three main refinery centers at Morawali and Konawe in Central and Southeast Sulawesi and Weda Bay in Maluku. 

That would open the way for Chinese firms to benefit indirectly from IRA tax credits, a violation of a provision in the legislation on battery technology or critical minerals sourced from “foreign entities of concern.”

A third issue stems from the exclusive use of coal to power Morawali and Weda Bay, which would seem to preclude Indonesia from benefiting from tax credits given the emphasis the IRA places on the use of renewables.

After a visit to Morawali last year, where labor problems have also been an issue, Tesla executives underlined Musk’s single-minded focus on clean energy, which were raised during the firm’s discussions with the Indonesians. 

Analysts doubt the US government will go for the limited FTA plan, narrowly focused as it is, saying officials first want to see more progress in Indonesia implementing the Group of Seven’s $20 billion Just Energy Transition Partnership (JETP) signed last November.

Under that program, funded from both public and private sources, Jakarta has pledged to cap omissions from the power sector by 2030, faster than the initial target of 2037, and to generate 34% of its electricity from renewable sources by the end of this decade.

In a recent opinion piece, American Indonesia Chamber of Commerce director Wayne Forrest described Indonesia’s path to an EV future as “simultaneously logical and confounding.” 

Logical, in the sense that it has abundant raw materials for value-added manufacturing, he says, but confounding if it can’t be done at affordable market prices and without distorting international markets.  

He notes that while Indonesia is the world’s second-biggest producer, it has never put an export ban in place for rubber, which has been just as important to gasoline-powered cars as nickel and other minerals are now to electric vehicles.

Forrest says apart from its central role in vehicles, rubber continues to play a crucial role in the health-care industry where newer uses of the material in protecting nurses and doctors would not have been widespread if exports were restricted.  

Last year, Indonesia earned more than $5 billion from its export of 3.14 million metric tons of natural rubber, which is mostly grown in North Sumatra, West and East Java and Kalimantan and employs 1.3 million workers.

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IN FOCUS: Why do underage maids risk working illegally in Singapore, and how do they slip through the cracks?

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WORK CAN BE “ISOLATING EXPERIENCE”

The need to provide for their families, lack of employment opportunities in their home countries, and promises of a better life are among the reasons why domestic workers go abroad for work, even though they could be breaking the law, said a spokesperson from migrant rights group Humanitarian Organisation for Migration Economics (HOME).

Underage maids will find it more difficult to cope with their work, which can be an isolating experience especially for first-time domestic workers, the spokesperson added.

“They live and work in their employers’ houses, and may not have strong community support, particularly if they have limited rest days and access to communication devices,” she said.

Domestic workers usually approach HOME for help with other issues. While having informal conversations with them or helping with their cases, HOME then discovers that they are underage or possibly underage.

“Some of them may be aware of the requirement but are told by their agents or employers to lie about their age so that they can continue working in Singapore,” the spokesperson added.

“Many of them do so as they fear losing their jobs if they are found out, and being blacklisted subsequently. This may make them stay in abusive or exploitative situations.”

If domestic workers are found to be younger than 23 and are reported to be so, they are usually repatriated.

The HOME spokesperson also pointed to a lack of regulation in domestic workers’ home countries.

For example, for about five years until 2019, Myanmar banned its citizens from becoming domestic workers in Singapore, Thailand, Hong Kong and Macau amid concerns of ill-treatment and abuse.

This allowed unscrupulous agents or middlemen to exploit underage workers as they need not follow regular channels, said the spokesperson.

“Since the ban was lifted, HOME has seen fewer underaged domestic workers from Myanmar. However, this issue is not specific to one country, and as long as there are individuals who wish to exploit underage individuals, the issue will persist,” she added.

Over at the Foreign Domestic Worker Association for Social Support and Training (FAST), new maids undergo a two-day onboarding and integration programme to help them adapt to life in Singapore.

FAST is supported by MOM and was founded in 2005 when the minimum age requirement kicked in.

Its chief executive director William Chew said that in 2018, the association had an 83 per cent retention rate for maids who went through the programme. It has not come across underage ones so far.

On the first day, domestic workers learn interpersonal and communication skills, house rules and working norms in Singapore, as well as self-care and motivational skills.

They then get to visit different markets on the second day, learn how to buy groceries and use public transport.

Mr Chew added: “Due to their young age, (underage workers) might not have the mental stability to cope with the culture shock, feelings of homesickness when they first arrive.

“Coupled with a lack of working experience and language barriers, they may find it hard to meet the rigorous expectations of employers in Singapore.”

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Tokyo needs to focus on its role as a middle power

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In 2018, we convened the Asia’s Future Research Group because of concern about the intensification of US-China geopolitical rivalry and the increasing risk of military clash in the Asia-Pacific region. The lack of balance in Japanese public discourse about how Japan should address this evolving strategic environment in Asia deeply troubled us.

We saw that not only Asia’s future but also Japan’s future was at a strategic crossroads. We therefore invited scholars and experts on Japanese foreign policy and international relations to join a multiyear project in order to develop a realistic and moderate Japanese strategy for Asia.

In December 2022, the Japanese government adopted a new “National Security Strategy” for the first time in a decade. Although it does not ignore the need for diplomatic dialogue and cooperation, what stands out is the strong emphasis on power politics (including military capabilities) and geopolitics as well as economic security.

The new strategy stresses the centrality of Japan’s self-defense capabilities and the US-Japan alliance. However, there exists a significant disparity between the paradigm presented in the new strategy document and Japan’s own capabilities.

Prime Minister Fumio Kishida reviews Self-Defense Forces troops on the anniversary of their establishment, November 27, 2021. Photo: Prime Minister’s Office of Japan)

Consequently, the US-Japan alliance is deemed essential to fill this gap; and in that sense, there is an element of logical consistency in the new strategy. Accordingly, strengthening the US-Japan alliance ends up being the strategy’s a priori premise and its absolutely indispensable prescription.

Our serious concern that the new paradigm will leave Asia entangled and divided in the future.

Japan’s long-held emphasis on a multifaceted and multilayered approach to Asia policy continues to be a constructive way to address the new regional and international challenges that have emerged. The transnational challenges that have become particularly prominent in recent years have acutely demonstrated the need for an unprecedented level of international cooperation. Nevertheless, recent foreign policy discourse around the world has tended to focus more on great power competition than on interstate cooperation.

In this context, Japan should maintain and promote security cooperation with the United States – but at the same time, it should also exercise leadership to help mitigate the competition between the US and China in Asia through constructive diplomacy, thereby reducing the danger of great power war in the region. Without this, there can be no solution to transnational problems and no progress toward a world free of nuclear weapons.

Such efforts and practices are consistent with the concept of “middle power diplomacy,” which aims toward a more autonomous foreign policy – one that is close to, but not solely
dependent on, the United States.

Approach toward Asia and the promotion of middle power diplomacy

One of the most important goals of Japan’s policy toward Asia is to promote further prosperity in the region through international trade, investment, and technological advances while making economic activities more environmentally sustainable and ensuring that the benefits of economic development are distributed more equitably.

To achieve this future vision, cooperation with countries that share values and similar political and economic institutions is crucial. Relations with the United States remain an important pillar of Japan’s foreign policy. However, using the rationale of strengthening the US-Japan alliance, Japan should not neglect countries that are not allies or partners of the United States.

To mitigate great power competition and prevent it from escalating into great power wars, Japan should deepen cooperative relationships with middle powers in the Asian region, such as South Korea, Australia, New Zealand, India and the Association of Southeast Asian Nations (ASEAN) and become a driving force of middle power cooperation.

While defending fundamental human rights and democratic principles, Japan should recognize the diversity of political systems in Asia and be sensitive to the different historical trajectories and sociocultural traditions in each country. Japan should resist moves to divide Asia into a struggle between democracies and autocracies and avoid an overly ideological approach to foreign policy.

Japan should also be cautious about defining the Asian region solely in terms of the “Indo-Pacific,” a concept that has recently been used frequently in international political
discourse.

Japanese Prime Minister Fumio Kishida meets with US President Joe Biden and Indian Prime Minister Narendra Modi. Photo: Wikipedia

While the concept of the Indo-Pacific has the advantage of emphasizing the importance of freedom of navigation and the security of long sea lanes vital to international trade, it has the drawback of viewing the Asian region primarily in maritime terms. The Indo-Pacific concept diminishes the importance of continental Asia and suggests an intention to counter or contain China.

Rather than concentrating on a single geographical concept, Japan’s diplomacy should reflect a multifaceted view that also incorporates the perspectives of “AsiaPacific,” “East Asia” and “Eurasia.”

Japan should reinvigorate its middle power diplomacy to build a more stable, peaceful and prosperous future for Asia. South Korea, which shares basic strategic interests and political values, is Japan’s most important partner in middle power diplomacy.

President Yoon Suk Yeol of South Korea listens to Prime Minister Fumio Kishida of Japan speak during their bilateral summit on March 16 in Tokyo. Photo: Yonhap

Japan can also build on the meetings involving Japan, Australia, India, and the United States – the Quad meetings – and take the lead in promoting a “middle power coalition” of Japan, Australia, and India. Inviting other Asian middle powers, such as South Korea and the ASEAN nations, to the mix would lead to the formation of a region-wide middle power alignment.

Japan should energetically engage China on the basis of partnerships with middle power countries in Asia and Europe to achieve stability in bilateral relations between Japan and China and cooperation on urgent transnational issues.

Regional economics

The Asian region has achieved remarkable economic development since World War II. At the same time, economic liberalization and rapid globalization that have driven this development have brought to the surface problems such as widening economic disparities and environmental degradation.

To mitigate such side effects and socio-political costs, Japan must place greater emphasis on sustainable development goals, which focus more on social and environmental protection.

In addition, the negative impact of the Covid-19 global pandemic and the disruption of international supply chains due to the Russia-Ukraine war, as well as China’s “weaponization of trade” and economic coercion have become prominent as new challenges of economic security.

Devising an effective response to these challenges is now an urgent priority for Japan and many Asian countries. Therefore, Japan’s regional economic diplomacy requires policies from three separate perspectives: economic liberalization, sustainable development and economic security.

Japan has played an important role in the Asian region in areas such as financial governance, trade promotion and development assistance cooperation, including infrastructure development. Building on this past success, Japan should continue to play a leadership role in rule making and cooperation in each of these areas as a leading economic power in Asia and a global middle power.

For example, Japan can make a meaningful contribution to implementing and expanding the Comprehensive and Progressive Agreement on Trans-Pacific Partnership (CPTPP), which is widely regarded as a high-standard free trade agreement in terms of trade liberalization and order building.

It can also help to devise an effective international debt restructuring program for Sri Lanka, which defaulted last year.

Anti-government protest in Sri Lanka on April 13, 2022, in front of the Presidential Secretariat. Photo: Wikimedia Commons

In the area of infrastructure development, Japan should continue to promote and realize its proposal to standardize the international principles of “quality infrastructure investment.” Encouraging China to follow these principles would help steer China’s investment
and support for infrastructure development toward sustainable economic development in the developing countries in Asia.

In addition, while various frameworks for regional economic cooperation exist in Asia, Japan’s basic position should be “open regionalism” and the prevention of a fragmented Asia.

From this perspective, Japan should promote cooperation under the US-led Indo-Pacific Economic Framework (IPEF), as a founding member. But Japan should also consider joining the Digital Economy Partnership Agreement (DEPA), which was launched by small and medium-sized Asia-Pacific countries (Singapore, Chile, and New Zealand) and is expected to expand its membership in the future, as well as the China-led Asian Infrastructure Investment Bank (AIIB).

Regional security

In order to maintain peace in Asia and to uphold Japan’s security, a certain level of deterrence is essential, but this raises the potential of a security dilemma. For deterrence to be effective, it is necessary not only to properly develop defense capabilities but also to provide some assurance to potential adversaries that their core interests will not be threatened.

Also, in pursuing defense cooperation between Japan and the United States, Japan should not hesitate to actively and openly express its views on security issues to the United States. A healthy alliance is not one in which Japan simply submits to US policies and intentions, but rather one in which Japan confidently engages in strategic dialogue with the United States on a more equal footing.

Regarding various Asian security issues, Japan should skillfully balance deterrence and diplomacy and pursue policies that contribute to reducing tensions and preventing crises.

With regard to North Korea, Japan should seek a realistic, gradual, reciprocal and step-by-step approach toward the ultimate goal of denuclearization of North Korea by making concrete progress on the resolution of the abduction issue.

With regard to the Taiwan issue, it is necessary to avoid a military crisis by maintaining conditions under which the status quo is preserved until the day comes when China and Taiwan can find a peaceful solution to the unification issue. To this end, it is important that both Japan and the United States convey to China in a credible manner that they clearly oppose any unilateral use of military force by China and at the same time have no intention of supporting Taiwan’s permanent separation or independence from China.

Meanwhile, the Senkaku Islands issue is one of the major factors undermining stability and cooperation in Sino-Japanese relations, and Japan should be creative in discussing with China various ideas for reducing tensions over those islands. Japan should politically revive and try to implement the Japan-China joint press release of June 2008 and the understanding on joint development in order to make the East China Sea a “sea of peace, cooperation, and friendship.”

The first pillar of Prime Minister Kishida’s “Hiroshima Action Plan” is the continued non-use of nuclear weapons. To strengthen this pillar, the Japanese government should publicly urge the nuclear weapon states to adopt a doctrine of “no first use” of nuclear weapons. By doing so, it will help institutionalize a global norm against the use of nuclear weapons.

By participating as an observer in the UN Treaty on the Prohibition of Nuclear Weapons, Japan can demonstrate international leadership toward nuclear disarmament as a long-term goal. Japan’s participation as an observer would not undermine US nuclear deterrence but rather serve as a bridge between the nuclear weapon states and non-nuclear weapon states.

Transnational challenges

Japan has heretofore made considerable contributions through international organizations and bilateral aid to address transnational issues such as global warming, pandemics of infectious diseases, and refugees from conflict in unstable regions. Based on this track record, Japan should continue to demonstrate its leadership in this area as a responsible major Asian country and a leading global middle power.

In addition, as an economically developed liberal democracy, Japan has an international responsibility to defend and promote universal human rights. In this regard, the concept of “human security,” which Japan has long advocated, is effective in dealing with these transnational challenges in Asia, where many countries tend to emphasize national sovereignty and a variety of political systems exist.

Therefore, Japan needs to promote more inclusive and effective regional and international cooperation, while keeping this concept as a basic principle and acting as a bridge across the geopolitical and ideological divides that have become more pronounced in recent years.

Specifically, Japan should work with other Asian countries to ensure that public health cooperation, such as Covid-19 vaccine provision, is not unnecessarily drawn into the intensifying Sino-American strategic competition.

Solar farm in Japan. Photo: Made in China

On climate change, given that both Japan and China are major carbon emitters in Asia, Japan should directly cooperate with China in the development and promotion of environmental technologies. This would not only enhance their ability to meet their own emission reduction targets, but also contribute to helping other Asian countries reduce their greenhouse gas emissions.

In the area of human rights and humanitarianism, Japan should first and foremost improve its own human rights and human security situation and lead by example. While refraining from bringing up human rights and democracy as ideological tools in the geopolitical competition with China, Japan should adopt practical humanitarian approaches that are in line with local realities.

For example, through existing frameworks such as the ASEAN Intergovernmental Commission on Human Rights, Japan can share best practices with other countries on improving government transparency and reforming legal and judicial systems and foster and support civil society actors involved in providing humanitarian assistance to victims of human rights abuses.

Major recommendations

Based on the above ideas, here are our specific recommendations for Japanese policy toward Asia:

  • In order to develop middle power diplomacy, lead the promotion of a “middle power coalition” of Japan, Australia, and India, which could drive the agenda-setting of the Quad (Japan, Australia, India, and the United States), and further strengthen functional cooperation with the Republic of Korea, ASEAN, and other middle power countries.
  • In response to the South Korean government’s decision regarding the “conscripted labor issue,” make continuous efforts to improve relations with South Korea.
  • Regarding debt restructuring measures for Sri Lanka, encourage China to participate continuously in the newly established “Creditor Committee for Sri Lanka” and cooperate by disclosing necessary information.
  • Encourage the return of the United States to the Comprehensive and Progressive Agreement on Trans-Pacific Partnership (CPTPP) and make diplomatic efforts toward the goal of simultaneous accession of China and Taiwan, which have formally applied for membership.
  • Explore the appropriate timing with a view to joining the Asian Infrastructure Investment Bank (AIIB).
  • With regard to rulemaking in the digital sector, consider applying for membership in the Digital Economy Partnership Agreement (DEPA), while promoting cooperation in the Indo-Pacific Economic Framework (IPEF).
  • Strengthen and deepen the doctrine of strictly defensive defense in the direction of enhancing deterrence by denial rather than focusing on counterstrike capabilities, which are less effective and have greater side effects.
  • Encourage North Korea to conduct another investigation into the abduction victims and establish a liaison office in North Korea to carry out such an investigation, with the aim of resuming negotiations for the normalization of diplomatic relations with North Korea.
  • Since a gradual, realistic, incremental, and reciprocal approach is needed to achieve the ultimate goal of denuclearization of North Korea, seek as a first step a freeze of North Korea’s nuclear weapons and missile development programs.
  • Based on paragraph 3 of the 1972 Japan-China Joint Statement, while opposing unilateral changes in the status quo from either side of the Taiwan Strait, clearly state that Japan does not support Taiwan’s independence.
  • Acknowledge the reality of the existence of an issue between Japan and China regarding the Senkaku Islands and discuss with China ways to ease and resolve tensions over the islands.
  • Urge the nuclear-weapon states to adopt a doctrine of “No First Use” of nuclear weapons and participate as an observer in the UN Treaty on the Prohibition of Nuclear Weapons.
  • Encourage inclusive transnational cooperation in the public health sector and work to reduce the negative impact of geopolitical tensions, ideological differences, and sovereignty conflicts on such cooperation.
  • Cooperate with China to promote environmental technologies and develop low-carbon infrastructure in third-country markets to address the climate change crisis in Asia.
  • Regarding human rights and human security, focus on improving the human rights situation at home while promoting a non-ideological, humanitarian approach that is practical in line with local realities in order to broaden support and cooperation among Asian countries

This article is excerpted with permission from the report “Asia’s Future at a Crossroads: A Japanese Strategy for Peace and Sustainable Prosperity,” published this week by the “Asia’s Future” Research Group. The group’s convenors are Yoshihide Soeya, professor emeritus of political science and international relations at at the College of Law of Keio University, and Mike Mochizuki, who holds the Japan-U.S. relations Chair in Memory of Gaston Sigur at the Elliott School of International Affairs of George Washington University and is also a non-resident fellow at the Quincy Institute for Responsible Statecraft.

Other authors and editors are Kuniko Ashizawa, who teaches international relations at the School of International Service, AmericanUniversity, and at the Elliott School of International Affairs, George Washington University; Miwa Hirono, a professor at the College of Global Liberal Arts at Ritsumeikan University; Saori Katada, a professor of international relations and the director of the Center for International
Studies at the University of Southern California; Kei Koga, an associate professor at the Public Policy and Global Affairs Program, School of Social Sciences, Nanyang Technological University, and concurrently a nonresident fellow at the US National Bureau of Asia Research and a member of the Research Committee at Japan’s Research Institute for Peace and Security; Jong Won Lee, a professor at the Graduate School of Asia-Pacific Studies, Waseda University; Kiyoshi Sugawa, a senior research fellow at the East Asian Community Institute; Takashi Terada, a professor of international relations at Doshisha University; Ambassador Kazuhiko Togo, a visiting professor at the Global Center for Asian and Regional Research, University of Shizuoka; and Hirotaka Watanabe, a professor at the Department of Political Science, Teikyo University.

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As Fed wraps up tightening, Chinese yuan breathes easier

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In: Asia

No government is probably happier that the US Federal Reserve is completing the most aggressive tightening cycle in decades than Xi Jinping’s.

Amid intensifying headwinds zooming China’s way, the idea of less monetary austerity in Washington – and fewer shocks in global capital markets – couldn’t arrive sooner. And odds are that Wednesday’s Fed interest-rate increase, the 11th in 17 months, is the last in the current campaign.

Yet there’s another reason the Fed taking a breather is comforting news for Xi: It relieves pressure on the yuan exchange rate.

As investors ratcheted down their expectations for China hitting 5% growth in recent weeks, the central bank found itself in a tug of war with currency speculators. Local media detailed how China’s major state-owned banks were dumping dollars for yuan in onshore and offshore markets to halt the renminbi’s slide.

This week, the plot thickened as top Community Party leaders meeting in Beijing pledged to keep a floor under the yuan exchange rate as part of vows to invigorate the capital market and buttress confidence.

“It’s interesting that the Politburo mentioned FX stability in the statement, for the first time in recent years,” analysts at HSBC observe in a note to clients. “This means that smoothing yuan depreciation pressure may become more of a policy priority from now on. This is in line with the People’s Bank of China’s further tightening of FX policy recently.”

On the dollar’s recent strength, strategists at RBC Capital Markets note that “the current rise has not been accompanied by as sharp a spike in volatility.” Thanks to nimble policymaking, they add, the yuan’s recent softness hasn’t turned “into an acute crisis situation.”

Beijing limiting the yuan’s downside is good news for four reasons.

One, it reduces default risks in the property market.

It’s not a given that Fed chairman Jerome Powell is done raising rates. As economist Seema Shah at Principal Asset Management puts it: “Data dependence remains the buzzword and, given the confusing signals of waning inflation but a tight labor market, keeping all options on the table seems to be a sensible approach” for the Fed.

Powell, after all, is keeping his options open after Wednesday’s move to raise the Fed’s benchmark rate to roughly 5.3% from 5.1%, the highest level since 2001. As Powell said on Wednesday, “it’s certainly possible that we will raise rates again at the September meeting. And I would also say it’s possible that we would choose to hold steady at that meeting.”

Longtime Fed watcher Diane Swonk at KPMG speaks for many economists when she says Powell’s directive was “about as clear as mud.”

What is clear, though, is that the steady decline in US inflation over the past year – to 3% from 9% – means the Powell Fed will soon take a back seat on US economic policymaking.

As the Fed throttles back on austerity, monetary-policy currents among top economies will remain uniquely divergent for the rest of 2023. It means that the conditions that propelled the dollar to the highest in decades are being reversed just as China is struggling to support the yuan.

As downward pressure on the yuan recedes, so will concerns that “China Evergrande” will be trending on global search engines. The weaker the yuan gets, the greater the risk property-development giants might default on dollar-denominated debt.

Quieter conditions in Chinese credit markets will make it easier for Xi’s reform team to end boom/bust cycles in the real-estate sector.

Two, it reduces the risk of an Asia-wide race to the bottom on exchange rates.

In recent months, many Asian policymakers worried the yen’s 7% drop this year would prod Beijing to follow suit. Nothing, after all, might ensure China reaches this year’s 5% GDP growth target faster than a sharp drop on the yuan.

That would set the stage for a region-wise response. Given still-lingering trauma from the late 1990s, fears that Tokyo’s beggar-thy-neighbor strategy might provoke responses from China to South Korea to Southeast Asia has been a major fear of US Treasury officials.

Back in the ’90s, the Fed’s aggressive rate increases boosted the dollar to levels that forced officials in Bangkok, Jakarta and Seoul to abandon currency pegs. Those competitive devaluations set in motion the 1997-98 Asian financial crisis.

In the decades since, governments strengthened banking systems, increased transparency, created bigger and more vibrant private sectors and amassed sizable foreign-exchange reserves to shield economies from global shocks.

The Covid-19 crisis, though, demonstrated that Asia is still too reliant on exports for growth. Even so, Asian governments over the past year have been more inclined to prop up exchange rates to limit the risks of imported inflation.

As Xi and Premier Li Qiang resist the urge to engineer a weaker yuan, the global financial system has breathed something of a sigh of relief.

Three, a stable yuan could help reduce trade tensions. Surely, it has dawned on US Treasury Secretary Janet Yellen that Beijing is displaying restraint in currency levels as Tokyo does the opposite. That might have been the reason Yellen’s team left China off Washington’s latest “currency manipulator” lists.

Even if Prime Minister Fumio Kishida’s Japan is pushing the weak-yen envelope, Beijing needs to tread carefully. As President Joe Biden runs for re-election, Republican challengers – many itching to investigate China over Covid-19 and suspicious of Asia in general – are sure to accuse Beijing of unfair currency manipulation.

Sanctioning China is, after all, perhaps the only thing on which Biden’s Democrats and Republicans agree. Xi’s team surely realized that while Donald Trump’s trade war and unhinged rhetoric were a drag, Biden’s more targeted and consistent curbs on China Inc since January 2021 have landed some notable blows.

All the more reason to avoid new tensions just as Premier Li’s team pivots toward creating greater economic space for China’s private sector to thrive. Part of the problem is China’s own success in de-emphasizing the public sector over the last 20-plus years.

Sure, Xi’s regulatory clampdown on Big Tech since late 2020 stymied progress on increasing the role of – and innovation in – the private sector. But Beijing is being reminded the hard way that the public sector’s share of urban employment – roughly 20% – no longer packs the punch it once did. It means that, this time, Xi and Li need a more vibrant private sector to boost income and confidence on the way to faster GDP growth.

Here, the policy shifts on display in Beijing this month, coupled with a less draconian Fed, are a plus for private-sector development in Asia’s biggest economy.

“This latest rhetoric from the top man of China’s State Council is likely to boost positive animal spirits in the short term at least,” says analyst Kelvin Wong at Oanda.

“From a medium-term perspective, the external environment also needs to be taken into consideration when global interest rates are likely to stay at a higher level for at least till the second half of 2024 given the latest hawkish monetary policy guidance from major developed countries’ central banks,” including the Fed.

Four, it suggests the shift to more productive growth is real. The latest signals coming out of Beijing are that Team Xi is more focused on long-term economic confidence than short-term-stimulus sugar highs.

The strategy “talks about boosting consumption but only indirectly, via supporting household incomes,” says Julian Evans-Pritchard, head of China economics at Capital Economics. “Those hoping for a new approach to stimulus involving greater transfers to households are likely to be disappointed.”

Economists at Barclays add that “while it signaled more support for the economy, the Politburo meeting generally fell short of offering large-scale stimulus. We view this as a signal that the government would stabilize growth around its target but refrain from an outsized policy response, given the top leaders’ intended shift in focus to quality.”

With a weak-yen obsession these last 25 years, Japan has amply proved that a weaker exchange rate may boost GDP, but does nothing to increase innovation, productivity or overall competitiveness.

If you are the CEO of a large or midsize company, why bother doing heavy lifting on restructuring, recalibrating, reimagining or reanimating innovative spirits when a weak exchange rate is bailing you out?

At the same time, internationalizing the yuan has arguably been Xi’s biggest reform victory these last 10 years.

In 2016, Xi’s government set the stage for yuan’s fast-increasing use in trade and finance when then-PBOC governor Zhou Xiaochuan secured a place for the yuan in the International Monetary Fund’s Special Drawing Rights program. It marked the yuan’s inclusion in the IMF’s club of reserve currencies, joining the dollar, euro, yen and pound.

Xi’s team has steadily increased and broadened the channels for foreign investors to access mainland China’s stock and bond markets. Chinese shares were added to the MSCI index, while government bonds were included in the FTSE Russell benchmark. That, and moves to increase financial transparency, increased global demand for the yuan.

Odds are good, says analyst Ming Ming at Citic Securities, that Xi’s government will continue to improve China’s capital-markets infrastructure to attract more long-term investment and boost direct financing.

Part of the process of building trust in the yuan is letting markets decide its value. The lack of full convertibility remains a big speed bump, of course. But so would the perception that Xi’s team and the PBOC are actively manipulating the yuan lower – provoking the Biden White House or the wider Group of Seven.

Beijing is focused on maintaining progress to date in internationalizing the yuan, and for good reason. That will get a bit earlier as the Fed ends a tightening cycle that Xi’s Communist Party will not miss.

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