ADB: Asian capital markets stabilizing, but recovery could be lengthy

By Angela McDaniels

Tacoma, Wash., April 21 - A new report from the Asian Development Bank said emerging Asia's capital markets are starting to stabilize and the region's relatively resilient economies should help them recover as the global crisis ebbs and investor appetite returns.

Nevertheless, ADB predicted in its Asia Capital Markets Monitor that the road to recovery for the region's equity, bond and currency markets will be long and hard given persistent uncertainty about the length and severity of the current economic downturn.

The Asia Capital Markets Monitor is a new annual publication that assesses the status and challenges for the region's markets, according to an ADB news release.

"Emerging Asia's financial markets were hit harder than expected last year," Jong-Wha Lee, head of the Office of Regional Economic Integration at ADB, said in the release. "But given that many emerging Asian economies will still grow this year while major global economies contract, Asia's financial markets should do better than most other regions going forward."

Flows

Net equity outflows from the region slowed significantly in the first quarter of 2009 after a sharp withdrawal of funds in the latter half of 2008, ADB said, signaling that foreign investors are far less pessimistic than they were about the region's prospects.

ADB predicted that for the full year, net private capital flows to the region will likely remain positive, although much lower than in 2007 when inflows hit a record high.

"The recent turmoil in Asia's markets is a reflection of the close interconnection between markets and economies around the world and underlines the need for governments and the financial sector globally to continuously improve regulation, oversight and risk management processes," Lee said.

Spreads soar

Emerging Asia's equity prices were down nearly 42% on the year as of March 31, according to ADB, with the markets in India, Indonesia and Thailand faring worst. Over the same period, the Dow Jones Industrial Average lost 16%.

Meanwhile, most emerging Asian currencies fell sharply against the dollar, and ADB attributed this to heightened risk aversion and massive deleveraging.

ADB said local-currency bonds held up well, but spreads over U.S. Treasuries of dollar-denominated bonds from the region soared, reflecting difficult external funding conditions.

In recent months though, emerging Asian equity markets have outperformed mature markets, with low valuations starting to attract buyers, ADB said. Offshore funding costs are falling, although they remain elevated by historical standards.

On the local bond market, issuance is set to expand as governments seek to fund fiscal stimulus packages, ADB said, adding that this will likely cap gains in local-currency bonds.

Although ADB expects most Asian currencies to recover somewhat over the course of the year, it said further depreciation is possible in the near term amid continued deleveraging and as weaker exports reduce dollar earnings in the region.

The report covers 11 economies of emerging Asia: the People's Republic of China, Hong Kong, India, Indonesia, Republic of Korea, Malaysia, Philippines, Singapore, Taipei, Thailand and Vietnam.

Bond markets

Total local-currency bond issuance in emerging Asia (excluding India) declined 59% year over year in the fourth quarter of 2008, ADB said, and corporate bond issuance fell 27%.

Issuance in emerging Asia is dominated by China, which accounted for 54% of total bonds outstanding. When China is excluded, year-over-year total local-currency bond issuance declined by only 6%, government issuance was flat and corporate bond issuance fell nearly 40%.

A sharp drop in issuance by central banks and monetary authorities led to a massive drop in local-currency bond issuance in emerging Asia in 2008, but ADB expects issuance should expand in 2009 as fiscal policy moves "center state in the fight against recession."

The bank also suggested that emerging Asia's recent issuance in G3 bond markets - the Eurozone, Japan and the United States - in G3 currencies can help fiscal and monetary stimulus take hold even if price discovery keeps risk premiums high.

Stimulus packages

On the topic of fiscal stimulus packages, ADB said the question is whether the borrowings required to finance the region's packages can be absorbed without putting upward pressure on interest rates given the stressed conditions in global markets.

Conditions in most emerging Asian local-currency bond markets remain relatively favorable, ADB said - bonds continue to be seen as the safe asset by domestic entities - but higher yields and more limited funding opportunities at the long end of yield curves could complicate the funding of stimulus packages and affect both the cost and effectiveness.

ADB said that when considering how best to structure and manage debt issued to finance the stimulus packages, the most important consideration should be given to the potential shifting of debt issuance toward shorter and medium-term maturity structures with maximum liquidity.

Investors in emerging Asian markets favor short-term maturities, ADB explained, and the bank said it might be prudent to weigh the implications of any broader seizing-up of liquidity in the region's bond markets should there be larger adverse spillovers from the global turmoil.

ADB estimated that the total government borrowing requirements in 2009 will jump to $172.1 billion in China, $68.5 billion in India and $133.7 billion in emerging Asia, excluding China and India.

In 2008, these figures were $34.0 billion in China, $59.5 billion in India and $69.7 billion emerging Asia, excluding China and India.

Turnover

ADB said turnover ratios fell sharply across emerging Asia's local-currency bond markets in 2008.

The turnover ratio measures the extent of trading in the secondary market relative to the value of bonds outstanding, according to the report - the higher the ratio, the more active the secondary market.

In 2008, turnover in government bonds was generally higher than corporate bonds.

The ratio for government bonds was less than 1 in Indonesia, Malaysia, Philippines, China and South Korea.

ADB said government bond markets in emerging Asia have been deepening, with an increase in buy-to-hold investors as the growing contractual savings industries search for scarce long-term local-currency assets to match long-term liabilities.

Turnover ratios for corporate bonds were below 0.4, except for China, which recorded a ratio of about 0.9. In 2007, the ratio was nearly 2.4 in China.

ADB attributed the low turnover ratios in corporate bonds to tight credit conditions, adverseness to trading higher-risk instruments and concerns about overall liquidity in this market segment.

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