ADB: Emerging East Asia local currency bond market sees rising risk

By Marisa Wong

Madison, Wis., Sept. 26 - Emerging East Asia's local currency bond markets are still expanding, but risks to the outlook are rising given the prospects of tighter U.S. monetary policy, slower economic growth in Asia and persistent capital outflows, according to the latest quarterly Asia Bond Monitor report from the Asian Development Bank (ADB).

"Asia's bond markets - and its borrowers - are better placed to stand up to this latest round of global volatility than they were in 1997-1998, but tough times certainly lie ahead," Iwan J. Azis, head of ADB's office of regional economic integration, said in a news release.

"The challenge will be to ensure the region can cope with higher borrowing costs and falling asset prices, which could hurt corporate balance sheets and dampen economic growth."

According to the release, the report warns that most governments in the region have missed the opportunity to raise cheap funds to finance critical infrastructure spending. That will be a further constraint on growth and poverty reduction going forward.

ADB said it estimates that Asia needs to spend at least $8 trillion on infrastructure between 2010 and 2020 to sustain economic growth.

At the end of June there was $6.8 trillion of local currency bonds outstanding in mainland China, Hong Kong, Indonesia, Korea, Malaysia, the Philippines, Singapore, Thailand and Vietnam, ADB reported. That amount is 1.7% more than at the end of March.

However, local currency bond issuance in the region is seeing a slower growth rate than the 2.9% expansion in the first quarter of 2013, with investors more cautious in the wake of the May announcement from the U.S. Federal Reserve that it would start tapering its bond purchases.

Some borrowers are holding back in the face of higher funding costs around the region.

There was $827 billion of new bonds sold between April and June, 4% more than in January through March, largely due to a 26.8% increase in issuance by central governments and agencies. Corporate issuance slumped 20.1% quarter-on-quarter to $168 billion as new bond sales by Chinese companies tumbled 48.8%. Excluding China, corporate issuance ticked up 1.4%, ADB reported.

Turmoil in the global financial markets has also made it harder and more expensive for emerging East Asian companies, particularly lower-rated firms, to borrow in the key foreign currencies - U.S. dollars, euros or yen. After $81 billion of issues in the first five months of 2013, June and July saw only a total of $7.5 billion raised.

Compared with 1997-1998 when Asia suffered a financial crisis, governments and companies now hold more of their debt in local rather than foreign currency, and the debt is now longer-dated. This means they are less vulnerable to currency depreciation and sudden shifts in borrowing costs and investor appetite, ADB explained.

To build resilience and support growth, the region needs to continue to develop more stable sources of funding, including more foreign direct investment, which tends to be more stable than capital market investment, and encouraging a wider range of bond investors, including pension funds, ADB suggested.

Insurance and pension fund investments, guarantees, and greater use of subordinated debt, alongside better project data, could also help channel more funds into transport, energy, telecommunications and other infrastructure.

The release also noted that market returns on Asian bonds have fallen sharply so far this year with the iBoxx Pan Asian index falling 3.5% in U.S. dollar, unhedged terms. Losses were largest in Indonesia, down 17.8%, and Singapore, down 7.8%. Only the Philippines and China saw gains of 7.5% and 3.1%, respectively.

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