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    Asia Bond Monitor: September 2011
    Asia Bond Monitor: September 2011
    Asia Bond Monitor: September 2011
    Ebook195 pages1 hour

    Asia Bond Monitor: September 2011

    By Asian Development Bank

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    About this ebook

    The Asia Bond Monitor (ABM) reviews recent developments in East Asian local currency bond markets along with the outlook, risks, and policy options. The ABM covers the 10 Association of Southeast Asian Nations member countries plus the People's Republic of China; Hong Kong, China; and the Republic of Korea.
    LanguageEnglish
    PublisherAsian Development Bank
    Release dateSep 1, 2011
    ISBN9789290924272
    Asia Bond Monitor: September 2011

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      Asia Bond Monitor - Asian Development Bank

      Emerging East Asian

      Local Currency Bond

      Markets:

      A Regional Update

      Highlights

      •The external environment facing emerging East Asia is bleak.¹ Market turbulence has prompted safe haven flows into gold, long-dated bonds, and higher quality corporate papers. The unresolved sovereign debt issues in the United States (US) and the ongoing eurozone debt crisis have led investors to re-think definitions of risk-free and risky assets.

      •Rising inflationary pressures in the first half of 2011 led to a steady stream of policy rate hikes across the region. However, the monetary policy stance in most markets could become more neutral as authorities in the region move to cushion against any anticipated slowdown in mature markets.

      •Capital flows into emerging East Asian bond markets remain strong as investors chase yields. Relatively strong economic fundamentals, interest rate differentials, and the potential appreciation of regional currencies are all key pull factors.

      •There has been a bullish flattening of government bond yield curves in most markets. Yields dropped sharply after the recent downgrade by Standard and Poor’s (S&P) of its sovereign rating for the United States to AA+ from AAA.

      •Total local currency (LCY) bonds in emerging East Asia grew 7.7% on a year-on-year (y-o-y) basis in 2Q11—and 2.4% on a quarter-on-quarter (q-o-q) basis—to US$5.5 trillion, driven more by the y-o-y growth rate for corporate bonds (19.6%) than for government bonds (2.7%).

      •The most rapidly growing bond markets in 2Q11 were Viet Nam, Singapore, and Malaysia, whose LCY bond markets expanded 5.0%, 4.3%, and 3.7% q-o-q, respectively. The People’s Republic of China’s (PRC) market grew 2.7% q-o-q in 2Q11, reflecting a modest 1.6% increase in its government bond sector, almost the same as for the region-wide government bond market.

      •Governments in three emerging East Asian economies—Hong Kong, China; the Republic of Korea; and Thailand—issued inflation-linked bonds in the first half of the year.

      •LCY bond issuance dropped sharply in 2Q11 on the back of a decline in issuance of short-term bills by central banks and monetary authorities, which was mostly a result of reduced sterilization activities. Meanwhile, authorities issued more at the long-end of the yield curve, taking advantage of the compression of spreads between 2- and 10-year government bonds.

      •Issuance by government sector entities—other than central banks and monetary authorities—rose 7.4% q-o-q and 11.6% y-o-y, while issuance from corporates increased 11.8% q-o-q and 10.7% y-o-y.

      •The corporate bond market in emerging East Asia expanded 4.4% q-o-q in 2Q11, led by Indonesia, which grew 8.9%, followed by the PRC, Malaysia, and Singapore.

      •The PRC’s corporate bond market grew at a rapid rate of 6.3% q-o-q in 2Q11 and is now the region’s largest corporate bond market, supplanting the Republic of Korea. The PRC’s medium-term note (MTN) sector is still the largest sector of the PRC corporate bond market, comprising 33.5% of the total.

      •Movements in corporate bond credit spreads for high yield and high grade bonds differed a great deal across markets in 2Q11. Credit spreads for high grade corporate bonds widened in the PRC, Malaysia, and Thailand, but tightened in the Republic of Korea. Credit spreads for Korean, Malaysian, and Thai high yield bonds tightened in 2Q11, while they were largely unchanged in the PRC.

      •G3 currency issuance in the region in 2011 reached US$55.4 billion through the end of July as funding conditions in global markets remained favorable. G3 issuance is on track this year to surpass the US$87.2 billion of issuance in 2010.

      •The risks to the outlook are tilted to the downside. These include (i) a severe slowdown or contraction in mature economies that might impact exports from the region, (ii) destabilizing capital flows, (iii) a lack of timely and appropriate policy interventions in mature markets, and (iv) potential commodity price fluctuations.

      Introduction: Global and Regional Market Developments

      The external environment facing emerging East Asian economies is bleak.² Unresolved sovereign debt issues in the United States (US) and an ongoing eurozone debt crisis has jolted global asset markets.

      Global stock market turbulence and rising volatility has fed investor fears and prompted safe haven flows into gold, the bonds of higher rated corporates with strong balance sheets, long-dated US treasuries, Japanese yen, and Swiss francs. The sovereign debt crises in mature markets and the potential impact on the wider economy have led investors to re-think their definitions of risk-free and risky assets. Furthermore, investors are now factoring in an extended period of weakness in the US and other mature economies. This worrying macro backdrop is likely to continue dampening investor sentiment in the medium-term.

      US treasury yields are hovering near historic lows,³ reflecting concerns over slowing global growth and debt sustainability in developed economies (Figure A). Mixed economic data and the unprecedented announcement of the US Federal Reserve that it will keep rates low over the next 2 years have fuelled expectations that growth may remain weak and further stimulus measures are in the offing.

      Corporate bond spreads in the US, Japan, and Europe have declined since the beginning of the year, although European corporate spreads have turned upward in recent weeks (Figure B). Rising risk aversion has sharply dragged down global equity markets, particularly in the aftermath of Standard & Poor’s (S&P) downgrade of US sovereign debt (Figure C).

      Emerging market economies are increasingly viewed as a relatively safe shelter. Investor preferences for emerging market assets are reflected in JP Morgan’s Emerging Markets Bond Index (EMBI) for sovereign stripped spreads (Figure D) as well as an outperformance in credit default swap (CDS) spreads for emerging East Asian government bonds (Figure E) at the same time that CDS spreads for European countries have presented a more mixed picture (Figure F).

      Capital flows into emerging East Asian bond markets remain strong as investors chase yields that are being buoyed by sound fundamentals, interest rate differentials—resulting from continued accommodative monetary policies in mature markets, and the potential appreciation of the region’s currencies.

      As the correlation between the index returns of US treasuries and Asian government bonds has weakened, capital flows into Asia have risen as investors seek returns and diversify away from mature markets (Figure G).

      Figure A: 10-Year Government Bond Yields (% per annum)

      Figure B: Corporate Bond Spreadsa

      Figure C: MSCI Indexes (January 2007 = 100)

      Figure D: JPMorgan EMBI Sovereign Stripped Spreadsc

      Figure E: Credit Default Swap Spreads (senior 5-year)c

      Figure F: Credit Default Swap Spreads for Select European and Emerging Markets (senior 5-year)c

      EMBI = Emerging Market Bond Index, UK = United Kingdom, US = United States.

      a. Bond spread refers to the difference between yields of 5-year bonds issued by BBB-rated finance companies and yields of sovereign benchmark bonds of the same tenor.

      b. Emerging Asia includes People’s Republic of China; India; Indonesia; Republic of Korea; Malaysia; Pakistan; Philippines; Taipei,China; and Thailand.

      c. US$ spread based on sovereign bonds.

      Note: Data as of 12 August 2011.

      Source: Thomson Reuters, Morgan Stanley Capital International (MSCI) Barra, and Bloomberg LP.

      Figure G: 5-Year US Treasury Yields and Correlation between Index Returns of US Treasuries and Asian Government Bonds

      Note: Data as of 12 August 2011.

      Source: Bloomberg LP.

      Demand for local currency (LCY) government bonds picked up in the middle of 2010 and remained strong throughout the first half of 2011. Overall, there has been a bullish flattening of yield curves in most markets; in many cases there has been a downward shift of the entire yield curve. Yields were pushed down even further in most markets after the S&P downgrade of US sovereign debt.

      Total LCY bonds outstanding in emerging East Asia grew 2.4% on a quarterly basis in 2Q11 to reach US$5.5 trillion, with growth driven more by the region’s corporate markets rather than its larger government markets. The most rapidly growing corporate bond markets in 2Q11 were Indonesia (8.9%), the People’s Republic of China (PRC) (6.3%), Malaysia (4.9%), and Singapore (4.7%).

      Growth in emerging East Asian economies is expected to moderate, yet remain relatively strong, in the second half of 2011. Inflation continued to rise in the first half of 2011 across much of the region, driven by higher commodity prices and the strong economic recovery. This led to increased issuance of inflation-linked sovereign bonds in some countries.

      At end–December 2010, emerging East Asia’s share of the global bond market stood at 8.0%, compared with only 2.1% before the onset of the 1997/98 Asian financial crisis (Table A). The two largest markets in the region were the PRC (4.7% of the global bond market) and the Republic of

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