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    Asia Bond Monitor: June 2016
    Asia Bond Monitor: June 2016
    Asia Bond Monitor: June 2016
    Ebook199 pages1 hour

    Asia Bond Monitor: June 2016

    By Asian Development Bank

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    About this ebook

    This publication reviews recent developments in East Asian local currency bond markets along with the outlook, risks, and policy options. It covers the 10 members of the Association of Southeast Asian Nations plus the People’s Republic of China; Hong Kong, China; and the Republic of Korea.
    LanguageEnglish
    PublisherAsian Development Bank
    Release dateJun 1, 2016
    ISBN9789292574949
    Asia Bond Monitor: June 2016

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      Asia Bond Monitor - Asian Development Bank

      Emerging East Asian Local Currency Bond Markets: A Regional Update

      Highlights

      Bond Market Outlook

      Bond yields in most emerging East Asian markets fell between 1 March and 15 May amid a weak global economy.¹ The exceptions were the People’s Republic of China (PRC) and the Philippines, where yields generally picked up.

      The United States (US) Federal Reserve continued to exercise caution in keeping interest rates steady at its Federal Open Market Committee meeting on 26–27 April. Global growth forecasts for 2016 have been revised downward amid sluggishness in the world economy. In March, the Asian Development Bank forecasts that developing Asia’s growth would decelerate from 5.9% in 2015 to 5.7% in 2016 and 2017.² In April, the International Monetary Fund cut its 2016 global growth forecast to 3.2%, down from 3.4% in January. Against this backdrop, bond yields in emerging East Asia generally decreased between 1 March and 15 May, including yields for 10-year local currency (LCY) government bonds.

      Emerging East Asian equity markets were up in all economies except Indonesia and Malaysia between 1 March and 15 May. The region’s currencies also generally strengthened against the US dollar during the review period, with the Korean won appreciating the most, followed by the Malaysian ringgit. Credit default swap spreads fell in emerging East Asian markets, indicating reduced perceptions of default risk.

      The generally benign picture for emerging East Asian LCY bond markets is subject to a number of risks. First, the US Federal Reserve may raise interest rates within the year, which could cause investors to pull back from the region’s bond markets. In addition, a broad-based global economic slowdown could amplify global financial instability and further dent global growth. Finally, deflation is emerging as a new risk to financial stability in emerging East Asia.

      Local Currency Bond Market Growth in Emerging East Asia

      The size of emerging East Asia’s LCY bond market expanded to USD9,608 billion at the end of March, up 3.9% quarter-on-quarter and 20.4% year-on-year in the first quarter (Q1) of 2016. The PRC’s bond market remained the largest in the region, accounting for a 67.7% share of emerging East Asia’s total bond stock at the end of March. The next two largest LCY bond markets were those of the Republic of Korea and Malaysia.

      Government bonds continued to dominate the region’s LCY bond market. Government bonds outstanding reached USD5,925 billion at the end of March, accounting for a 61.7% share of the region’s aggregate bond stock. Corporate bonds outstanding reached a size of USD3,683 billion. All markets in the region except the Republic of Korea’s have a larger proportion of government bonds than corporate bonds.

      As a share of gross domestic product (GDP), emerging East Asia’s LCY bond market climbed to 65.4% in Q1 2016 from 63.7% in the fourth quarter of 2015, with gains coming from both the government and corporate bond segments. The Republic of Korea had the largest share of bonds to GDP in the region at the end of March at 129.8%, which is a reflection of its well-developed bond market. The next two largest bond markets in the region as a share of GDP were those of Malaysia (97.4%) and Singapore (77.9%).

      LCY bond issuance in emerging East Asia totaled USD1,052 billion in Q1 2016, down 2.2% quarter-on-quarter but up 51.0% year-on-year. Of this amount, government bonds accounted for 63.8% and corporate bonds for 36.2%.

      Structural Developments in Local Currency Bond Markets

      With the US Federal Reserve leaving its policy rates unchanged thrice in the first 5 months of the year, emerging East Asia’s LCY bonds remained attractive to foreign investors, owing to their relatively high interest rates. The share of foreign holdings in LCY government bond markets rose in most emerging East Asian economies for which data are available.

      The share of foreign holdings rose in the LCY government bond markets of Indonesia and Malaysia in Q1 2016, buoyed by their recovering currencies. In the Republic of Korea, the share of foreign investors’ government bond holdings rose only marginally in the fourth quarter of 2015.

      Foreign investor participation in emerging East Asia’s LCY corporate bond market remains weak due to the market’s illiquid nature. In Indonesia, the share of foreign investor holdings of corporate bonds fell to 7.4% at the end of March from 7.6% at the end of December. The share of foreign investor holdings in the Republic of Korea’s corporate bond market accounted for an insignificant 0.2% of the total corporate bond stock at the end of December.

      Net foreign capital inflows into emerging East Asian bond markets were strong in the first 4 months of the year. All emerging East Asian markets for which data are available showed net bond inflows every month from January through April, with the exception of the Republic of Korea, which posted net inflows only for the months of March and April.

      Local Currency Bond Yields

      Amid the backdrop of the US Federal Reserve leaving its key policy rate unchanged at its March and April meetings, yields for most tenors fell between 1 March and 15 May in all of the region’s markets except those of the PRC and the Philippines. Weak global growth also contributed to the decline in yields.

      The 2-year yield fell during the review period for all emerging East Asia economies with the exception (again) of the PRC and the Philippines. The pattern was similar for the 10-year yield except in the PRC where the 10-year rate was roughly stable.

      Credit spreads between AAA-rated corporate bonds and government bonds fell for most tenors in the Republic of Korea and Malaysia during the review period. In Malaysia, sentiment improved over firmer oil prices. In the PRC, on the other hand, credit spreads rose due to a number of corporate debt defaults in the first half of 2016. Lower-rated corporate spreads in the PRC also rose, while they were unchanged in the Republic of Korea and Malaysia.

      Theme Chapter: Drivers of Sovereign Bond Yields in Emerging Asia

      Yield movements for 5-year LCY bonds varied across emerging Asia during the period 2000–2015, indicating evolving perceptions of the region’s individual bond markets.³

      Inflation has consistently shown to be a significant factor in determining yields. However, the impacts of consumer price inflation and producer price inflation on yields differ across economies, which suggests the need for tailored policy prescriptions depending on the drivers of consumer and producer inflation in a given economy.

      Domestic liquidity is also an important yield driver. To the extent that it influences inflation and economic growth, there is a role for monetary authorities in promoting bond market liquidity.

      The global economic environment also affects the region’s bond yields, emphasizing the importance of domestic macroeconomic stability and bond market resilience in the face of global uncertainty.

      Global and Regional Market Developments

      Bond yields in most emerging East Asian markets fell between 1 March and 15 May against the backdrop of a weak world economy.⁴ The main exceptions were the People’s Republic of China (PRC) and the Philippines, where yields picked up during the review period. Bond yields in most major economies also declined, reflecting very low inflation bordering on deflation.

      The overall trend of declining yields reflects a number of factors. The United States (US) Federal Reserve continued to exercise caution and decided to keep interest rates steady during Federal Open Market Committee meetings on 15–16 March and 26–27 April. The US Federal Reserve moderated its concerns over the world economy and presented a mixed overall picture of the US economy that included slowing economic activity, below-target inflation, and strengthening job market conditions. The central bank finds itself in a delicate situation in which the cases for and against higher interest rates are finely balanced, yet it decided to err on the side of caution.

      Within emerging East Asia, the People’s Bank of China reduced its reserve requirement ratio by 50 basis points (bps) on 1 March. Bank Indonesia has lowered its benchmark interest rate three times by a cumulative 75 bps since the beginning of the year.

      The International Monetary Fund (IMF) cut its 2016 global growth forecast to 3.2% in its World Economic Outlook published in April, down from 3.4% in January, although it projected an uptick to 3.5% growth in 2017. The downward revision was driven by a number of trends. The advanced economies are still struggling to fully overcome the after effects of the global financial crisis. As a result, growth in advanced economies as a whole is projected to stall at 1.9% in 2016 before picking up only marginally to 2.0% in 2017. US growth is expected to remain flat at 2.4%, with only a slight acceleration to 2.5% in 2017. Strengthened public finances and an improved housing market notwithstanding, the strong dollar is impeding export growth and net exports thus remain a major drag on growth. High unemployment and weak investment are weighing on the eurozone’s growth, which is projected by the IMF to reach only 1.5% in 2016 and 1.6% in 2017. In Japan, growth of 0.5% and −0.1% is projected for 2016 and 2017, respectively, amid tepid private consumption.

      Emerging markets are also contributing to the IMF’s downward revision to its global growth forecast. Subdued global commodity prices are slowing growth in emerging markets in Latin America, the Middle East, and elsewhere. Emerging East Asia is not only adversely affected by the gloomy global outlook, but is also contributing to it. For example, the PRC’s ongoing growth slowdown is impacting both the regional and global outlook. In March 2016, the Asian Development Bank (ADB) projected developing Asia’s growth to decelerate from 5.9% in 2015 to 5.7% in both

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